Securities lawsuits involving either cryptocurrencies or bitcoin have tripled so far this year, according to a new report by Lex Machina. Not surprisingly, the Securities and Exchange Commission (SEC) filed 30 percent of the cases.
Lex Machina’s Securities Litigation Report of 2018 analyzed trends involving a wide range of securities suits, including both private litigation and regulatory actions. It specifically compared securities cases filed from July 1, 2015, to December 31, 2016, which is just prior to SEC Chair Jay Clayton taking the helm, to those brought from January 1, 2017, to June 30, 2018.
Lex Machina’s findings confirm that while there is a perception that the SEC is relaxing its enforcement, the numbers say otherwise. There were 1,097 securities cases filed in 2016 and 1,676 in 2017, an uptick of 50 percent. The findings also confirm that the SEC means business with respect to its cryptocurrency crackdown and oversight over initial coin offerings (ICOs). According to the report, there were 45 cases filed so far this year that mentioned “blockchain,” “cryptocurrency” or “bitcoin” in the filings. That is compared to 15 in all of 2017.
“At a very high level, we think it’s an interesting trend because the popular narrative might be that securities enforcement under the new administration, given its deregulatory and other policy positions, might have fallen,” said Owen Byrd, the general counsel at Lex Machina. “We thought it was noteworthy and newsworthy to uncover that filings had increased at the very time when you might think from other signals in the sphere of news that the trend might have gone another way.”
SEC’s First Cryptocurrency Enforcement Action Against Hedge Fund
On September 11, the SEC filed its first cryptocurrency enforcement action against a hedge fund. According to the SEC, Crypto Asset Management, LP violated federal securities laws by not registering as an investment company with the SEC. The hedge fund, which touted itself as the “first regulated cryptoasset fund in the United States,” raised $3.6 million from 44 U.S. investors. Crypto Asset Management, LP agreed to pay a $200,000 penalty and is now offering securities pursuant to the Regulation D Rule 506(c) exemption from registration.
In another recent action, the SEC waged charges against TokenLot, as well as its heads Lenny Kugel and Eli Lewitt. According to the agency, the company, which called itself an "ICO Superstore," acted as an unregistered broker-dealer for the sale of digital tokens. The defendants agreed to pay $471,000 in disgorgement plus interest to settle the charges, without admitting or denying the allegations.
State Regulators Take Aim at Cryptocurrency
While the SEC is taking the lead in policing cryptocurrency, the North American Securities Administrators Association (NASAA) has also launched its own crackdown. It launched “Operation Cryptosweep” in May and recently announced that it has expanded the number of investigations into initial coin offerings from 75 to 200.
"A strong culture of compliance should be in place before, not after, these products are marketed to investors," NASAA President and Alabama Securities Commission Director Joseph P. Borg said in a statement. "While not every ICO or cryptocurrency-related investment is a fraud, it is important for individuals and firms selling these products to be mindful that they are not doing so in a vacuum; state and provincial laws or regulations may apply, especially securities laws."
FINRA Asserts Its Oversight Over Cryptocurrency
The Financial Industry Regulatory Authority (FINRA) also recently made headlines for bringing its first disciplinary action related to cryptocurrency. FINRA filed a complaint against Timothy Tilton Ayre of Massachusetts, charging him with securities fraud and the unlawful distribution of an unregistered cryptocurrency security called HempCoin.
In its complaint, FINRA alleges that Ayre marketed HempCoin as “the world’s first currency to represent equity ownership” in a publicly traded company and promised investors that each coin was equivalent to 0.10 shares of common stock in his public company, Rocky Mountain Ayre, Inc. (RMTN). Investors mined more than 81 million HempCoin securities through late 2017 and bought and sold the security on two cryptocurrency exchanges. FINRA charges Ayre with the unlawful distribution of an unregistered security because he never registered HempCoin and no exemption to registration applied. FINRA also alleges that Ayre defrauded investors in RMTN by making materially false statements and omissions regarding the nature of RMTN’s business, failing to disclose his creation and unlawful distribution of HempCoin, and making multiple false and misleading statements in RMTN’s financial statements.
Message for Businesses and Investors
As highlighted above, state and federal regulators are closely scrutinizing the cryptocurrency industry. They are paying particular attention to ICOs because they are generally considered securities subject to SEC oversight. Prior to launching or investing in an ICO, we strongly encourage you to consult with experienced securities counsel regarding the potential risks and benefits.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work at 201-806-3364.