Summary of the SEC Actions Following the DAO Report

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The Securities and Exchange Commission (SEC) was established in 1934 by the Securities Exchange Act of 1934 with the express mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The Great Crash of 1929 and the subsequent pressure on Congress to protect investors from the fraudulent sale of stock that was rampant at the time led to the enactment of the Securities Act of 1933 and subsequent the Securities Exchange Act of 1934 which created the SEC. According to the SEC, the main purpose of the laws can be reduced to two common sense notions:

  • Companies publicly offering securities for investment dollars must tell the public the truth about their businesses, the securities they are selling, and the risks involved in investing.
  • People who sell and trade securities – brokers, dealers, and exchanges – must treat investors fairly and honestly, putting investors’ interests first.

The growth enthusiasm in the DLT and cryptocurrencies space and reports of frauds and hacks were thus bound to attract the attention of the SEC. The initial steps of taken by the SEC was largely to caution both founders of the DLT and cryptocurrencies project of the need to abide by the existing laws in regards to issuance of securities and warning of the inherent risks for the investors.

Here we provide brief descriptions of some of the key statements and or actions taken by the SEC from since the issuance of the DAO report back in July 2017.

Release No. 81207 / July 25, 2017

Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934:The DAO

The report was based on investigation by SEC that intended to established whether the DAO, unincorporated organization, Slock.it, a German corporation, Slock.it’s co-founders; and intermediaries may have violated the federal securities laws.  The investigation concluded that ‘whether or not a particular transaction involves the offer and sale of a security regardless of the terminology used – will depend on the facts and circumstances, including the economic realities of the transaction . Those who offer and sell securities in the United States must comply with the federal securities laws, including the requirement to register with the Commission or to qualify for an exemption from the registration requirements of the federal securities laws. The registration requirements are designed to provide investors with procedural protections and material information necessary to make informed investment decisions. These requirements apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology. In addition, any entity or person engaging in the activities of an exchange, such as bringing together the orders for securities of multiple buyers and sellers using established non-discretionary methods under which such orders interact with each other and buyers and sellers entering such orders agree upon the terms of the trade, must register as a national securities exchange or operate pursuant to an exemption from such registration.’

August 28, 2017

INVESTOR ALERT: PUBLIC COMPANIES MAKING ICO-RELATED CLAIMS

The SEC’s Office of Investor Education and Advocacy warned investors about potential scams involving stocks of companies claiming they are engaging in ICOs. According to the SEC these frauds include “pump-and-dump” and market manipulation schemes involving publicly traded companies that claim to provide exposure to the new technologies. The SEC also mentioned its several trading suspensions of certain issuers who made claims regarding their investments in ICOs or touted cryptocurrency related news (namely: First Bitcoin Capital Corp., CIAO Group, Strategic Global, and Sunshine Capital).

September 29, 2017
SEC EXPOSES TWO ICOs BACKED BY REAL ESTATE AND DIAMONDS
The SEC alleged that Maksim Zaslavskiy and his companies have been selling unregistered securities, and that the tokens being sold don’t really exist. According to the SEC’s complaint, investors in REcoin Group Foundation and DRC World (also known as Diamond Reserve Club) have been told they can expect sizeable returns from the companies’ operations when neither has any real operations. Mr. Zaslavskiy and REcoin allegedly misrepresented they had raised between $2 million and $4 million from investors when the actual amount was approximately $300,000. The SEC’s complaint, filed in federal district court in Brooklyn, N.Y., charged Zaslavskiy, REcoin, and Diamond with violations of the anti-fraud and registration provisions of the federal securities laws. The complaint seeks permanent injunctions and disgorgement plus interest and penalties. The SEC also seeks an officer-and-director bar and a bar from participating in any offering of digital securities.

November 1, 2017

SEC URGES CAUTION AROUND CELEBRITY BACK ICOs
SEC’s Enforcement Division and Office Compliance Inspection issued statement against celebrities promoting ICOs without complying with the relevant regulations on disclosure which requires such promoters to disclose the nature, source, and amount of any compensation paid, directly or indirectly, by the company in exchange of the endorsement. Failure to disclose this information by the promoters is a violation of the anti-touting provisions of the federal securities laws. It is worth noting that in the recent past, the SEC had brought enforcement proceeding against 27 firms (not blockchain related) out of alleged anti-touting provisions of the securities laws. Over half of the defendants agreed to settlements ranging from $2,200 to nearly $3 million based on the severity of their actions.

December 4, 2017
SEC EMERGENCY ACTION HALTS ICO SCAM

The SEC filed charges against a recidivist Quebec securities law violator, Dominic Lacroix, and his company, PlexCorps. The SEC’s complaint, filed in federal court in Brooklyn, New York, alleges that Lacroix and PlexCorps marketed and sold securities called PlexCoin on the internet to investors in the U.S. and elsewhere, claiming that investments in PlexCoin would yield a 1,354 percent profit in less than 29 days. The SEC also charged Lacroix’s partner, Sabrina Paradis-Royer, in connection with the scheme. These charges were the first filed by the SEC’s new Cyber Unit created in September 2017.

December 11, 2017
COMPANY HALTS ICO AFTER THE SEC RAISES REGISTRATION CONCERNS
The SEC issued an order instituting cease-and-desist proceedings pursuant to section 8A of the Securities Act of 1993, making finding, and imposing a cease-and-desist order against Munchee Inc, a California legitimate business providing food review service. The SEC established that the MUN token was a security offering  pursuant to Section 2(a)(1) of the Securities Act. It was the view of the SEC that the purchaser of the MUN had a reasonable expectation of obtaining a future profit based on Munchee’s efforts, including Munchee revising its app and creating the MUN ecosystem using the proceeds from the sale of the MUN tokens.

December 11, 2017

SEC CHAIRMAN JAY CLAYTON PERSONAL STATEMENT

The SEC chairman confirmed that the SEC had not registered any exchange-trade product by the time and warning ordinary investors to be vigilant of potential fraud and loss of their investment. While acknowledging the valuable contribution of ICOs as vehicles for project fundraising, he was clear that any activity that involved offering of securities should be accompanied by the required disclosures, processes and other investor protections as provided in the securities laws. He made it also clear that any structural changes do not affect the fundamental point of abiding by the securities laws. The chairman viewed the efforts of certain professionals to highlight utility characteristics of their token in an effort to escape their characterization as security to be a futile elevation of form over substance.

January 30, 2018

SEC HALTS ALLEGED INITIAL COIN OFFERING SCAM

SEC obtained a court order halting an allegedly fraudulent ICO that targeted retail investors to fund what it claimed to be the world’s first “decentralized bank”. According to the SEC’s complaint, filed in federal district court in Dallas, Dallas-based AriseBank used social media, a celebrity endorsement, and other wide dissemination tactics to raise what it claimed to be $600 million. The SEC alleged that AriseBank falsely stated that it purchased an FDIC-insured bank and that it also offered customers the ability to obtain an AriseBank-branded VISA card to spend any of the 700-plus cryptocurrencies. AriseBank also allegedly omitted to disclose the criminal background of key executives. This is the first time the SEC sought the appointment of a receiver in connection with an ICO fraud, which was approved by the court, enabling the receiver to immediately secure various cryptocurrencies held by AriseBank.

February 6, 2018

SEC CHAIRMAN’S TESTIMONY: THE ROLES OF THE SEC AND CFTC

In his testimony before the United States Senate Committee on Banking, Housing, and Urban Affairs, SEC Chairman Jay Clayton expressed his optimism in the developments in the financial technology for Main Street, the institutional investors and even the regulators who will be in better position to monitor transactions, holdings and obligations. All these depended on the strict adherence to the laws. In pointing out the gaps in existing regulations, the chairman stressed the choice of most cryptocurrency exchanges opting to be regulated as money transmission services, a service that is predominantly regulated at state level, despite the fact that traditional money transfer services do not quote prices or offer other services akin to securities, commodities and currency exchange. Nevertheless he suggested the primary entry point into SEC’s jurisdiction for project fundraisers to be the sale and offer of securities as set forth in the Securities Act of 1933.

February 16, 2018

SEC SUSPENDS TRADING IN THREE ISSUERS
SEC suspended trading in another three companies (Cherubim Interest Inc., PDX Partners Inc. and Victura Construction Group Inc.) due to the questions surrounding claims by the three to have acquired cryptocurrency and blockchain-related assets and other compliance problems, including announcement of an ICO launch by one of the companies.

February 21, 2018

SEC CHARGES BITCOIN EXCHANGE

SEC alleged that BitFunder and its founder Jon E. Montroll operated BitFunder as an unregistered online securities exchange and defrauded exchange users by misappropriating their bitcoins and failing to disclose a cyberattack on BitFunder’s system that resulted in the theft of more than 6,000 bitcoins.The SEC also alleged that Montroll sold unregistered securities that purported to be investments in the exchange and misappropriated funds from that investment as well.

March 7, 2018
STATEMENT ON UNLAWFUL PLATFORMS FOR TRADING DIGITAL ASSETS
SEC through the Division of Enforcement and Trading Markets issued a detailed warning against cryptocurrency exchanges which provided mechanism of trading assets that meet the definition of securities without necessary registration with the SEC.

May 29, 2018

SEC OBTAINS EMERGENCY ORDER HALTING FRAUDULENT ICO

SEC complaint charges that Titanium President Michael Alan Stollery, a.k.a. Michael Stollaire, a self-described “blockchain evangelist,” lied about business relationships with the Federal Reserve and dozens of well-known firms, including PayPal, Verizon, Boeing, and The Walt Disney Company. The complaint alleges that Stollaire promoted the ICO through videos and social media and compared it to investing in Intel or Google.

Concluding Remarks

From the foregoing, we can make two salient observations, namely the prudence of ensuring one’s project complies with existing laws in the jurisdiction(s) the project seeks to operate and secondly, SEC influence on the trajectory of developments in the regulations of DLT projects across the world.

From the project’s perspective, it is very clear from the foregoing that founders of projects in the DLT space will have to give serious considerations to SEC position and demonstrated intention to ensure their conformity with existing securities laws. Having honest intentions, avoiding misleading marketing gimmicks, self-characterization of tokens as utility token and having elaborated terms & conditions full of disclaimers, is simply very far from competent determination of one’s project exposure to legal risks.

Secondly, as regulators around the globe continue studying or drafting regulations and guidelines for the Fintech sector, the influence of SEC position is becoming clearer. The approach taken so far by regulators across the globe has either been broadening of definitions and application  of existing regulations or drafting of new regimes purposely for the DLT / Blockchain space. In both approaches, SEC position on individual determination of the characterization of tokens and the attendant regulatory and compliance approach seems to gain traction across jurisdiction.

Ahmed Ali and Tomas Elbert

Diacle