United States: Recent Crackdown Highlights SEC's Growing Crypto Scrutiny

The U.S. Securities and Exchange Commission brought three enforcement actions concerning digital assets in rapid succession in a week, underlining that the Division of Enforcement is as committed to crypto enforcement under SEC Chair Gary Gensler as it was under former Chair Jay Clayton.

These actions come on the heels of Gensler's Aug. 3 speech before the Aspen Security Forum.¹ Gensler's views were clear: "Right now, we just don't have enough investor protection in crypto. Frankly, at this time, it's more like the Wild West."²

Many digital tokens are unregistered securities because they are investment contracts under the test the U.S. Supreme Court established in 1946 in SEC v. Howey Co.³ Securities that trade on crypto trading platforms, including decentralized finance, or DeFi, platforms and the platforms themselves must be registered with the SEC, Gensler said.

The three recent enforcement actions include:

• SEC v. Uulala Inc. et al, an action settled on Aug. 4 in the U.S. District Court for the Central District of California, alleging both registration and antifraud violations against an issuer and its two founders for raising more than $9 million through an unregistered offering of digital assets;⁴
• In the Matter of Blockchain Credit Partners et al., an administrative proceeding, settled Aug. 6, against an issuer and two individuals that marks the first SEC enforcement action in the DeFi space;⁵ and
• In the Matter of Poloniex LLC, an administrative proceeding, settled Aug. 9, against an unregistered crypto exchange.⁶

A summary of each of these actions follows the takeaways.

Takeaways: A Week in the Wild West

1. The SEC is focused on digital assets that function like investment contracts

In case there was any doubt before, it is now clear that the SEC continues to view unregistered digital asset offerings, including initial coin offerings, or ICOs, with suspicion under the Howey test. Uulala and Blockchain Credit Partners represent the SEC's latest enforcement actions taking the position that digital tokens are investment contracts, similar to the allegations against Kik Interactive Inc. and Telegram Group Inc. settled in 2020.⁷

Indeed, during his speech, Gensler agreed with Clayton's view that "every ICO I have seen is a security."⁸

2. Registration violations may be compounded by allegations of fraud.

The SEC will not hesitate to investigate and prosecute alleged fraud in connection with unregistered digital asset offerings, which can lead to increased civil penalties for defendants, including individuals. In both Uulala and Blockchain Credit Partners, the SEC scrutinized the defendants' statements about their technology, operations and financial performance to bring fraud charges. The fraud charges led to individual civil penalties that ranged from $50,000 to close to $200,000 per individual defendant.

3. The SEC can move relatively quickly in the crypto space.

In Blockchain Credit Partners, the settlement came 18 months after the issuer commenced operations and just six months after it ceased operations.

4. The SEC has its eye on digital asset trading platforms.

Platforms must comply with the registration requirements of Section 5 of the Securities Exchange Act,⁹ or risk enforcement action if the SEC determines that a digital asset trading on its platform is a security.

Gensler believes that "[t]he test to determine whether a crypto asset is a security is clear."¹⁰ But Commissioners Hester Peirce and Elad Roisman have called on the SEC to provide clear insight - outside the enforcement context - into the SEC's investment contract determinations.¹¹

In the meantime, crypto trading platforms must rely on the SEC's past enforcement actions to make informed decisions about the digital assets that can be traded on their platforms.

5. Regulatory clarity is key to foster innovation in the crypto industry.

Despite Gensler's calls for rulemaking in the crypto space,¹² Peirce continues to express frustration at what she perceives as the slow pace of crypto regulations and other clarity from the SEC.

Peirce is in favor of a narrow regulatory safe harbor against registration violations to foster innovation, reflected in her dissent when Unikrn Inc. was ordered to permanently disable its blockchain-based token and its integrated product offerings, and pay a $6.1 million civil penalty representing substantially all the company's assets, for the sole charge of conducting an unregistered offering.¹³

In Poloniex, Peirce dissented from the SEC's decision to charge the company for failing to register as an exchange or as an alternative trading system while the SEC is yet to fully develop a framework for regulated entities to interact with digital assets.¹⁴

To view the full article click here

Footnotes

1. Gary Gensler, Chair, U.S. Sec. and Exch. Comm'n, Remarks Before the Aspen Security Forum (August 3, 2021), available at: https://www.sec.gov/news/public-statement/gensler-aspen-security-forum-2021- 08-03.

2. Id.

3. SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (an investment contract exists when money is invested in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others).

4. SEC v. Uulala, Inc., et al., No. 5:21-cv-01307 (C.D. Cal.), available at: https://www.sec.gov/litigation/litreleases/2021/lr25157.htm.

5. In the Matter of Blockchain Credit Partners d/b/a DeFi Money Market, Gregory Keough, and Derek Acree, AP File No. 3-20453 (August 6, 2021), available at: https://www.sec.gov/litigation/admin/2021/33-10961.pdf.

6. In the Matter of Poloniex, LLC, AP File No. 3-20455 (August 9, 2021), available at: https://www.sec.gov/litigation/admin/2021/34-92607.pdf.

7. SEC v. Telegram Grp. Inc., et al., No. 19 Civ. 9439 (S.D.N.Y.), available at: https://www.sec.gov/litigation/complaints/2019/comp-pr2019-212.pdf; SEC v. Kik Interactive Inc., No. 19-cv-5244 (S.D.N.Y.), available at: https://www.sec.gov/litigation/complaints/2019/comp-pr2019- 87.pdf.

8. Gensler at Aspen Security Forum, supra note 1.

9. Section 5 of the Exchange Act makes it unlawful for any broker, dealer, or exchange, directly or indirectly, to effect any transaction in a security, or to report any such transaction, in interstate commerce, unless the exchange is registered as a national securities exchange under Section 6 of the Exchange Act, or is exempted from such registration. 15 U.S.C. § 78e.

10. Gary Gensler, Chair, U.S. Sec. and Exch. Comm'n, Letter to Senator Elizabeth Warren (August 5, 2021), available at: https://www.warren.senate.gov/imo/media/doc/gensler_response_to_warren_- _cryptocurrency_exchanges.pdf.

11. Hester M. Peirce and Elad L. Roisman, Commissioners, U.S. Sec. and Exch. Comm'n, Public Statement In the Matter of Coinschedule (July 14, 2021), available at: https://www.sec.gov/news/public-statement/peirce-roisman-coinschedule.

12. Gensler at Aspen Security Forum, supra note 1; see also CNBC, SEC Chairman Gary Gensler says more investor protections are needed for bitcoin and crypto markets (May 7, 2021), available at: https://www.cnbc.com/2021/05/07/sec-chairman-gary-gensler-says-more-investor-protections-areneeded-for-bitcoin-and-crypto-markets.html.

13. Hester M. Peirce, Commissioner, U.S. Sec. and Exch. Comm'n, Public Statement on SEC Settlement Charging Token Issuer with Violation of Registration Provisions of the Securities Act of 1933 (September 15, 2020), available at: https://www.sec.gov/news/public-statement/peirce-statement-settlementcharging-token-issuer; see also Haimavathi Marlier, Susan Gault-Brown, and Dario de Martino, Taming Unikrns? The SEC's Recent Digital Asset Offering Enforcement Actions (September 24, 2020), available at: https://www.mofo.com/resources/insights/200924-unikrn-sec-digital-asset-enforcementactions.html.

14. Hester M. Peirce, Commissioner, U.S. Sec. and Exch. Comm'n, Public Statement In the Matter of Poloniex, LLC (August 9, 2021), available at: https://www.sec.gov/news/public-statement/piercestatement-poloniex-080921.

Originally published by Law360

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved