The Dawn of a New Era: The Securities and Exchange Commission Sets its Sights on Initial Coin Offerings 

By Hannah Taylor*

 Though it has been a decade since the advent of cryptoeconomics, U.S. agencies have yet to formulate a comprehensive regulatory scheme to protect consumers and investors.[i] On February 18, 2018, White House cybersecurity coordinator Rob Joyce suggested that new regulations of digital assets were firmly in the inchoate stage because of looming uncertainty in the understanding of the field’s “good ideas and bad ideas”.[ii] Although White House officials may be still be “unravel[ing] the benefits and drawbacks of . . . the bitcoin concept,” large scale investment in cryptoeconomies continues.[iii]

Despite hesitations at the executive level, administrative bodies and the judiciary have been itching to forge new paths on the landscape of crypto-regulation. Among these actors, the Securities and Exchange Commission (“SEC”) in recent weeks has asserted itself at the helm of crypto-regulatory enforcement by taking action against an Initial Coin Offering (“ICO”).

In multiple joint statements at the end of January 2018, the SEC and the U.S. Commodity Futures Trading Commission (CFTC) expressed motivation to “look beyond form” and “examine the substance of the activity” in their regulatory efforts.[iv] Later, ahead of a congressional hearing before the Senate Banking Committee, both the SEC and CFTC issued statements on February 6th about the need for increased oversight with regards to virtual currency.[v] However, the agencies have differing approaches in mind. The CFTC classifies victual currency as a commodity, which would mean “fraud and manipulation involving” cryptocurrencies fall directly under its authority.[vi]  On the other hand, the SEC has pursued regulation of cryptocurrencies as securities.[vii] The SEC reiterated in the 2017 “21(a) Report” that some virtual currencies may qualify as securities under its classification standard “depending on the particular facts and circumstances, without regard to the form of the organization or technology used to effectuate a particular offer or sale.”[viii] Though securities and commodity regulation can work in tandem, this lack of consensus captures the multiple and often conflicting perceptions of how to think about virtual currency and cryptoeconomics on traditional economy.

The SEC has maintained firm resistance to cryptocurrencies by not approving their listing or trading.[ix] On February 21, the SEC charged Jon Montroll (founder of BitFunder) for “operating an unregistered securities exchange and defrauding users of that exchange.”[x] The civil charges offer concrete affirmation of the SEC’s stance that “activities of a national securities exchange, regardless of whether that activity involves digital assets, tokens, or coins, must register with the SEC.”[xi] Furthermore, in conjunction with the SEC’s investigation, the Federal Bureau of Investigation (“FBI”) and the U.S. Justice Department are pursuing criminal charges against the Montroll for defrauding investors on the now defunct exchange platform.[xii]

Historically, the SEC has acted with similar reluctance regarding ICOs by resisting their registration.[xiii] Touted as an unregulated alternative to initial public offerings (“IPOs” where a private company puts shares up for public sale), ICOs use virtual tokens instead of shares to raise capital.

When it comes to regulation of ICOs, the SECs emerges as the clear regulatory leader in light of its recent enforcement actions. For the first time in history of virtual currency, on January 25, 2018, the SEC has seized cryptocurrency believed to be fraudulent.[xiv]

In an enforcement action, the SEC has seized crypto assets like bitcoin, dogecoin, and litecoin from a Dallas based company, AriseBank, which raised over $600 million dollars in an ICO without registering securities with the SEC.[xv] The SEC also alleges that AriseBank improperly cast itself as a banking institution, misrepresenting its ability to provide customers with FDIC insured accounts.[xvi] Steven Peikin, a co-director of the SEC’s Enforcement Division, stated in a press release that marks “the first time the Commission has sought the appointment of a receiver in connection with an ICO fraud” in the hopes that the appointed receiver will be able to recover investor capital.[xvii] The assert freeze is “the biggest action yet” for the SEC in its quest to bring this emerging market to heal.[xviii] The SEC’s groundbreaking action reiterates that the virtual marketplace is not immune to fraud and does not provide a safe harbor from agency regulation.

In fact, the SEC’s recent seizure suggests that further agency regulation of cryptocurrency is forthcoming. Now that the SEC has brought an enforcement action against an ICO it may be time for the SEC to provide a path towards registration. As March 2018, there are have been no registered ICOs with the SEC or exchange-traded products holding cryptocurrencies.[xix] As cryptoeconomies grow, it will become increasingly untenable for the SEC to regulate in this area without providing for the legitimate operation of the ICOs that deal in securities. As we wait for more comprehensive multi-agency regulation, there may be some more immediate alternative strategies available to protect investors and consumers. One such procedural change that presents itself as low hanging fruit would be to make IPOs easier to launch, decreasing market demand for alternative solutions.

Moving forward there has been a demonstrable increase in efforts from agencies to in the area of cryptoregulation. According to the Morrison Cohen, LLP, a regulatory litigation tracker, there have been 12 cases or enforcement actions regarding cryptocurrency through February 2018 by agencies such as CFTC, SEC, and FIRNA. Completely eclipsing the twelve such proceedings initiated in all of 2017.[xx] As cryptocurrency and its platforms grow, so do the opportunities for misappropriation of funds, which necessitate agency interference.

*Hannah Taylor is a Junior Editor on MJEAL. She can be reached at hannahmt@umich.edu.

 


The views and opinions expressed in this blog are those of the authors only and do not reflect the official policy or position of the Michigan Journal of Environmental and Administrative Law or the University of Michigan.

[i] The foundation for cryptoeconomies was laid down in 2008 by Satoshi Nakomoto. Ameer Rosic, What is Cryptoeconomics, BlockGeeks (September 2017), https://blockgeeks.com/guides/what-is-cryptoeconomics/

[ii] Sam Bourgi, U.S. Crypto Regulation Unlikely to Materialize in Near Future: White House Official, Hacked (February 2018), https://hacked.com/u-s-cryptocurrency-regulation-unlikely-materialize-near-future-white-house-official/

[iii] Id.

[iv] Laura Anthony, The SEC and CFTC Joint Statements on Cryptocurrencies; Global Regulators Join in, Legal and Compliance, LLC (February 6, 2018), http://securities-law-blog.com/2018/02/06/the-sec-and-cftc-joint-statements-on-cryptocurrencies-global-regulators-join-in/

[v] Phil Glazer, State of Cryptocurrency Regulation, Hacker Noon (February 5, 2018)

https://hackernoon.com/state-of-cryptocurrency-regulation-february-2018-a316c291320

[vi] Id.

[vii] Patricia Hurtado, Can Bitcoin be Regulated; US Courts Are About to Decide, Bloomberg News (January 29, 2918),  https://www.bloomberg.com/news/articles/2018-01-29/can-bitcoin-be-regulated-u-s-courts-are-about-to-decide

[viii] U.S. Securities and Exchange Commission, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934, (July 25, 2017), https://www.sec.gov/litigation/investreport/34-81207.pdf

[ix] Phil Glazer, State of Cryptocurrency Regulation, Hacker Noon, (February 5, 2018),

https://hackernoon.com/state-of-cryptocurrency-regulation-february-2018-a316c291320

[x] U.S. Securities and Exchange Commission, SEC Charges Former Bitcoin-Denominated Exchange and Operator with Fraud, (February 21, 2018),  https://www.sec.gov/news/press-release/2018-23

[xi] Id.

[xii] Stan Higgins, Government Arrests Bitcoin Stock Exchange Founder, Coindesk (Feb 21, 2018),   https://www.coindesk.com/us-government-arrests-bitcoin-stock-exchange-founder/

[xiii] Phil Glazer, State of Cryptocurrency Regulation, Hacker Noon (February 5, 2018)

https://hackernoon.com/state-of-cryptocurrency-regulation-february-2018-a316c291320

[xiv] Id.

[xv] Matt Robinson, SEC Freezes Crypto Assets of $600 Million Initial Coin Offering, Bloomberg Markets (January 30, 2018), https://www.bloomberg.com/news/articles/2018-01-30/sec-seeks-to-freeze-crypto-assets-of-600-million-coin-offering?utm_content=tictoc&utm_campaign=socialflow-organic&utm_source=twitter&utm_medium=social&cmpid%3D=socialflow-twitter-tictoc

[xvi] Evelyn Cheng, SEC Halts One of the largest ‘ICOs’ Ever as it Wades Deeper into the Murky World of Cryptocurrency Offerings, CNBC (January 30, 2018) https://www.cnbc.com/2018/01/30/sec-halts-one-of-the-largest-icos-ever.html

[xvii] U.S. Securities and Exchange Commission, SEC Halts Alleged Initial Coin Offerings Scam, (January 30, 2018), https://www.sec.gov/news/press-release/2018-8

[xviii] Matt Robinson, SEC Freezes Crypto Assets of $600 Million Initial Coin Offering, Bloomberg Markets (January 30, 2018), https://www.bloomberg.com/news/articles/2018-01-30/sec-seeks-to-freeze-crypto-assets-of-600-million-coin-offering?utm_content=tictoc&utm_campaign=socialflow-organic&utm_source=twitter&utm_medium=social&cmpid%3D=socialflow-twitter-tictoc

[xix] John Clayton, Statement on Cryptocurrencies and Initial Coin Offerings, (December 11, 2018) https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11

[xx] Morrison Cohen LLP, Cryptocurrency Litigation Tracker, (April 10, 2018), https://www.morrisoncohen.com/news-page?itemid=471

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