Tuesday, October 09, 2018

Securities Regulation Daily’s top 10 developments for September 2018

By Lene Powell, J.D.

In a major caution for companies to take a close look at their social media policies, the SEC decisively reined in Elon Musk, the famously glib chief of Tesla, Inc., in the wake of his August tweet that he had secured a deal to take Tesla private. In late September, the SEC charged Musk with securities fraud and Tesla with having inadequate disclosure controls. When the dust settled two days later, Musk and Tesla each agreed to pay a $20 million penalty, and Musk agreed to be removed as Tesla chairman. The settlements are subject to court approval.

The SEC also swung the hammer at three former officers of the now-defunct law firm Dewey & LeBoeuf for their involvement in falsifying the firm’s financial results. The Southern District of New York ordered Steven H. Davis to pay a $130,000 civil penalty and imposed an officer and director bar, as well as smaller disgorgement orders against the firm’s finance director and controller.

In another big enforcement development, the SEC paid out the second largest whistleblower award in its history, awarding $39 million to one whistleblower and $15 million to another. Notably, the second claimant received the award even though the SEC determined that the information was not given “voluntarily,” in that he or she submitted the tip after appearing before another regulatory agency for an investigative interview. Due to a variety of factors, the SEC granted a waiver on this point.

September was a blockbuster month for virtual currency developments. The District of Massachusetts ruled that a virtual currency called “My Big Coin” was a commodity for purposes of a CFTC enforcement action under the Commodity Exchange Act, and the Southern District of New York decided that cryptocurrency tokens in two initial coin offerings (ICOs) were securities under the Securities Act and Exchange Act, at least at the motion to dismiss stage.

Further, FINRA staked its claim in the space with its first cryptocurrency enforcement action, and the SEC settled its first enforcement actions against an unregistered digital asset fund manager and unregistered broker-dealers selling digital tokens. SEC Enforcement Co-Director Stephanie Avakian also signaled that the Division of Enforcement will likely soon begin recommending substantial penalties against ICO issuers that fail to comply with securities registration requirements.

Somewhat softening this broadside, Commissioner Hester Peirce urged “humility” in the SEC’s response to cryptocurrencies and cautioned against regulatory overprotectiveness. In a speech that earned her the nickname “CryptoMom” in the Twittersphere, she warned that stifling innovation in the regulated markets would cause investors to seek out new products in less-regulated markets.

Read more below for more detail, and keep up with the WK Securities team on Twitter by following @WK_Securities and on LinkedIn at https://www.linkedin.com/showcase/securities-law/.


Musk will step aside as Tesla chairman as part of settlement with SEC

Elon Musk quickly settled the SEC’s fraud charges by agreeing to several actions, including stepping down as chairman of Tesla. He also agreed to appoint two independent directors to the company’s board, and he and Tesla will pay $40 million in penalties. Musk will be replaced by an independent chairman, but is eligible to be reelected as chairman after three years. See our full coverage.


Former Dewey & LeBoeuf execs fined $181K for cooking the books

The SEC settled charges against three former executives of the now-defunct Dewey & LeBoeuf law firm for their involvement in a fraudulent bond offering that relied on materially misstated financial results. The Southern District of New York imposed a $130,000 civil penalty and officer and director bar against former chairman Steven H. Davis, as well as disgorgement orders against the firm’s former finance director and controller. See our full coverage.


Whistleblower awarded second largest award in SEC history

After giving the SEC critical information and continued assistance in bringing an important enforcement action, the SEC has determined to award $39 million to one whistleblower and $15 million to another. See our full coverage.


Virtual currency is a ‘commodity’ for purposes of CFTC fraud claims

The Massachusetts district court has declined to dismiss a complaint alleging a fraudulent "virtual currency scheme" in violation of the Commodity Exchange Act and CFTC regulations. According to the court, the virtual currency at issue is a "commodity" within the meaning of the Act, and the antifraud provisions of CEA Section 6(c)(1) and Regulation 180.1 are not restricted only to cases involving market manipulation. See our full coverage.


Crypto assets in alleged ICO fraud passed the Howey test; indictment stands

In an indictment for criminal securities fraud involving two initial coin offerings (ICOs), the U.S. successfully argued at the motion to dismiss stage that the investments in the allegedly fraudulent offerings were investment contracts and thus securities under the Securities Act and Exchange Act. The Southern District of New York also found that the Exchange Act and SEC Rule 10b-5 were not unconstitutionally vague as applied in this case. See our full coverage.


FINRA smokes out HempCoin fraud in first crypto enforcement action

In the SRO’s first enforcement action involving virtual currencies, FINRA has charged a former Massachusetts broker with fraudulently selling an unregistered cryptocurrency security called HempCoin. FINRA alleges that Timothy Tilton Ayre attempted to attract investments into the worthless public company he controlled by offering interests in what he touted as the "the first minable coin backed by marketable securities." According to FINRA, however, Ayre misrepresented his company’s business and financial status in OTC Pink Market filings while failing to register the HempCoin interests with the SEC. See our full coverage.


First enforcement action against unregistered digital asset hedge fund manager settles

A hedge fund manager falsely calling itself the first regulated crypto asset fund has been sanctioned for operating as an unregistered investment company. The Commission found that the California-based company and its sole principal conducted an unregistered, non-exempt public offering and then invested over 40 percent of the fund's assets in digital asset securities. The firm and principal agreed to pay a $200,000 penalty and consented to a cease and desist order and censure. See our full coverage.

8. ICOs

Unregistered broker-dealers settle SEC’s first digital token case

Michigan unregistered broker-dealers selling digital tokens settled with the SEC in the Commission’s first case charging unregistered broker-dealers with selling digital tokens after the 2017-released Digital Asset (DAO) Report. The broker-dealers agreed to pay $471,000 in disgorgement, $7,929 in interest and $45,000 in penalties, along with consenting to industry and penny stock bars and an investment company prohibition with the right to reapply after three years. See our full coverage.

9. ICOs

Avakian highlights enforcement efforts involving ICOs, share class disclosures

As she approaches the end of her first full fiscal year as Co-Director of the SEC’s Enforcement Division, Stephanie Avakian highlighted what she regards as some of the Division’s greatest success stories during her tenure. In particular, she focused on the Division’s approach to dealing with initial coin offerings (ICOs) and mutual fund share class disclosures. Avakian's remarks came before the University of Texas School of Law’s 5th Annual Government Enforcement Institute in Dallas, Texas. See our full coverage.


Commissioner Peirce urges ‘humility’ in regulatory response to cryptocurrency

Seeming to embrace the new moniker of "CryptoMom," SEC Commissioner Hester Peirce told attendees of the Cato Institute’s FinTech Unbound Conference that she would likely be a "free-range" mother that would encourage a child to learn and explore with limited supervision. This approach requires acceptance of a certain level of risk, she acknowledged, but achievements are often only possible with a certain level of risk-taking. Citing her recent dissents from decisions to block exchange-traded products designed to give investors access to bitcoin, Peirce noted that the capital markets are all about risks and suggested that the SEC "helicopters in with good intentions, but often without sufficient concern for the way its blades roil the markets, frustrate innovation, and potentially expose investors to greater risks." Investors should have access to a wide variety of investment options and be able to evaluate risks for themselves, the commissioner opined. See our full coverage.