The Financial Industry Regulatory Authority (“FINRA”) announced on Tuesday, September 11, 2018, its first disciplinary action for securities violations against a cryptocurrency. The disciplinary action involves Rocky Mountain Ayre, Inc. (RMTN) in connection with its issuing and selling of HempCoin, which was marketed as “the first minable coin backed by marketable securities”. Ayre bought the rights to HempCoin in 2015 and effectively securitized HempCoin by backing it with RMTN’s publicly traded common stock. HempCoin was touted as the “the world’s first currency to represent equity ownership” in a publicly traded company and promised investors that each coin was equal to 0.10 shares of RMTN common stock. Through late 2017, investors were able to mine more than 81 million HempCoin securities and subsequently buy and sell the coin on two cryptocurrency exchanges. FINRA alleges in its complaint that Ayre defrauded investors in RMTN by making materially false statements and omissions regarding the nature of RMTN’s business. Such false statements include failing to disclose its creation and unlawful distribution of HempCoin, and misleading statements in RMTN’s financial statements. Ayre is charged with the ‘unlawful distribution of an unregistered security’, as HempCoin was not registered with the SEC nor did the issuer use a registration exemption.
The same day as the FINRA announcement, the SEC issued two separate cease-and-desist orders. The first cease-and-desist order was issued to a cryptocurrency hedge fund, Crypto Asset Management (“CAM”) who misrepresented itself as the “first regulated crypto asset fund in the United States”. The SEC claims that the CAM has not registered with the SEC and “willfully” misrepresented itself as having the proper credentials to trade and hold securities. The second cease-and-desist order was issued to self-proclaimed “ICO Superstore” TokenLot, for failing to register with the SEC. The heads of TokenLot have agreed to pay a fine to settle the charges that they acted as an unregistered broker-dealer for the sale of tokens. Similar to most investigations, these two have already been resolved via the payment of fines. These two cases may signal that the SEC is beginning to go after companies that have failed to comply with securities laws out of negligence, rather than overt fraudulent activities.
Although the SEC has previously issued statements that Bitcoin and Ethereum are not securities, to date, the SEC has declined to issue broad or narrow classifications or taxonomies as to which cryptocurrencies are securities, and which are not. It is worth remembering, however, that, ultimately, the SEC is only a regulatory body that enforces the law. Thus, these issues will likely be left to the courts to ultimately decide.
On September 11, 2018, a New York federal judge in U.S. v. Zaslavskiy ruled that U.S. securities laws applied to prosecuting fraud allegations involving cryptocurrency. Zaslavsky was charged in November 2017 for securities fraud related to two ICOs: ReCoin and DRC. In February 2018, Zaslavsky filed a motion to dismiss claiming that he did not commit securities fraud because ReCoin and DRC are not securities and that the U.S. securities laws are unconstitutionally vague because an ordinary person would not have known that his conduct was illegal under current securities laws. The judge denied his motion to dismiss on the grounds that ReCoin and DRC are, in fact, securities assuming the Department of Justice’s allegations are true, and the U.S. securities laws are not so vague as to be unconstitutional. The judge’s denial of Zaslavskiy’s motion to dismiss means the case will proceed to trial. Zaslavskiy is expected to argue that the relevant tokens were not investment contracts under the Howey Test.
These three announcements issued on the same day demonstrate how seriously regulators and courts are taking cryptocurrency despite their late start and lack of definitive guidance surrounding the law to date. We will keep monitoring these developments as more announcements are made.
Commentary by Stan Sater & Jeffrey Bekiares, Esq. Jeff is a securities lawyer with over 8+ years of experience, and is co-founder at both Founders Legal and SparkMarket. He can be reached at firstname.lastname@example.org