DeFi Company and Executives Settle SEC Charges for Unregistered Securities Offering
A company that sold digital tokens using smart contracts and "decentralized finance" ("DeFi") technology and its two executives (the company and its executives, collectively, the "Respondents") settled SEC charges for the unregistered sale of over $30 million of securities. The action is the SEC's first involving the sale of securities through the use of DeFi technology.
In the Order, the SEC stated that the company used smart contracts to offer two types of digital tokens: one that paid 6.25 percent in interest, and one that purported to give holders specific voting rights, a percentage of excess profits and the ability to profit from the token's secondary market resales. The SEC determined that the tokens constituted "investment contracts" under SEC v. W. J. Howey because the premise of the investment in the tokens was the investors' reasonable expectations of profitability through the company's efforts in operating a marketplace for the tokens called the "DeFi Money Market."
In addition, the SEC found that the company falsely claimed to back the digital tokens through the purchase of car loans. The SEC determined that soon after offering the tokens, the Respondents realized that the price volatility risks posed by the digital assets could lead to the assets generating insufficient income to compensate for the appreciation of investors' principal. The SEC stated that as a result, the Respondents falsely represented that the company purchased car loans to back the assets when, in fact, the loans the company presented on its website were owned by a separate company that was controlled by the two executives. To pay out interest on the tokens and finance any token redemptions, the SEC found that the Respondents used their personal funds and funds from the other company they controlled.
The Respondents voluntarily shut down the company's operations in February 2021, and paid all principal and interest owed to investors using personal funds and funds from the separate company controlled by the two executives.
As a result of its findings, the SEC determined that the company violated Sections 5(a) ("Sale or delivery after sale of unregistered securities"), 5(c) ("Necessity of Filing Registration Statement") and 17(a) ("Use of Interstate Commerce for Purpose of Fraud or Deceit") of the Securities Act, Section 10(b) ("Regulation of the Use of Manipulative and Deceptive Devices") of the Exchange Act and SEA Rule 10b-5 ("Employment of Manipulative and Deceptive Devices").
Without admitting or denying the SEC's findings, the Respondents agreed to (i) cease and desist from future violations and (ii) pay to the SEC a disgorgement totaling $12,849,354, plus $258,052 in prejudgment interest. In addition, the two executives agreed to each pay a $125,000 civil money penalty and to accept a five-year ban from acting as an officer or director of an issuer with a class of securities registered under Exchange Act Section 12 ("Registration Requirements for Securities") or subject to the filing requirements under Exchange Act Section 15(d) ("Supplementary and Periodic Information").
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