SEC Charges Crypto Firms with Unregistered Securities Offering
Commentary by Steven Lofchie
The SEC charged two crypto firms, one an issuer and the other its agent, with conducting an unregistered securities offering through a program where retail investors, among others, could "loan" crypto-assets to the issuer in return for an obligation of the issuer to return the assets with interest.
In the Complaint, filed in the Southern District of New York, the SEC stated that the "loaned" crypto-assets were loaned out to financial institutions at a higher rate of interest, or used by the issuer for its own purposes. The issuer entered into an agreement specifying the amount of interest the investor would earn, reduced by the fee to be taken by the agent. The SEC reported that following significant volatility in the digital asset market, the issuer has not returned to investors the crypto-assets they loaned and the issuer is now undergoing a restructuring.
The SEC asserted that, under the Reves test, the lending program in which retail investors exchanged crypto-assets for a promise of the return of the assets plus interest constituted "notes," i.e., securities. The offering of the notes was made to the general public and thus should have been registered under the Securities Act, the filing said. The SEC also argued that the program constituted the offer and sale of investment contracts under the Howey test because it involved the investment of money in a common enterprise with an expectation to profit from the efforts of the program.
The SEC said that the alleged misconduct violates Securities Act Section 5(a) and 5(c) ("Prohibitions relating to interstate commerce and the mails"). The SEC is seeking (i) permanent injunctive relief, (ii) disgorgement of ill-gotten gains plus prejudgment interest, (iii) civil monetary penalties and (iv) any additional relief the Court deems appropriate.
Commentary
The SEC has been criticized for failing to attempt either to make clear when a digital asset is, or is not, a security; and has not made any attempt to develop a disclosure regime tailored to digital assets.
This case presents a different problem. Here the type of financing program at issue is clearly a security under Reves. It is not a close call.
In Coinbase, the issue involved a lending program that Coinbase wanted to initiate, but was discouraged from doing so by the SEC. That case was problematic because the SEC failed to explain in plain English why Coinbase's proposed plan required registration under the Securities Act.
According to the SEC's complaint in the instant matter, the issuer went bankrupt with over $900 million of assets raised from over 300,000 investors. It is hard to see how that flew under the radar. This is not a situation where there are difficult legal questions as to jurisdiction; this appears to be a clear violation of the securities laws on a large scale. The SEC's bringing an action now seems too late to be meaningful.
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On The Coinbase Blog, Chief Legal Officer Paul Grewal stated that the SEC issued a notice to Coinbase indicating the agency's intention to bring an enforcement action against Coinbase if it launched its proposed "Coinbase Lend" program.