By Amanda Maine, J.D.
SEC Assistant Regional Director Steven Buchholz joined members of the defense bar for a discussion about cryptocurrency enforcement and litigation. The panel discussed recent SEC enforcement efforts against Telegram and Kik, as well as other cryptocurrency-related cases brought by the CFTC, the Department of Justice, and the Treasury Department. Securities Docket hosted the panel as part of its 2021 Securities Enforcement Forum West.
Recent SEC crypto cases. According to Buchholz, since the start of the pandemic, the SEC filed well over 20 enforcement actions involving digital assets, bringing the total to nearly 80 enforcement actions (plus over 20 trading suspensions) since 2017. It’s fair to say that enforcement action in this space is not slowing down, Buchholz remarked. Regarding the substance of these cases, a little more than half are traditional fraud cases involving cryptocurrency and digital assets claims, while the rest consist of registration violations, broker-dealer and exchange violations regarding digital assets, instances where promoters of cryptocurrency did not disclose their compensation, and pooled investment vehicles.
Buchholz also highlighted some recent federal court wins for the SEC in cryptocurrency cases. In March 2020, a federal court granted the SEC’s request for a preliminary injunction against Telegram. The court’s detailed opinion outlined how the company’s "Grams" were investment contracts under the Howey test and therefore needed to be registered with the SEC or qualify for an exemption. In a later settlement with the SEC, Telegram agreed to pay an $18.5 million penalty and return over $1 billion to investors as disgorgement, as well as notify the SEC of any token offerings for three years.
The SEC also prevailed on a motion for summary judgment against Kik Interactive in September 2020. The court agreed with the SEC that Kik’s "Simple Agreements for Future Tokens" (SAFTs) that either claimed to be exempt under Regulation D or were public token sales were investment contracts and were integrated into a single offering. Kik agreed to pay a $5 million penalty and to provide notice to the SEC about any digital asset offerings for three years.
Buchholz briefly described some ongoing litigation the SEC is pursuing in the cryptocurrency world. The SEC sued NAC Foundation for misrepresentations and registration violations regarding its blockchain-based digital token called AML BitCoin. NAC touted AML BitCoin as having anti-money laundering (AML), know-your-customer (KYC), and other security features encoded in the smart contracts for the token. Convicted lobbyist Jack Abramoff found himself in hot water again, settling registration and fraud charges with the SEC relating to his promotional activities for AML BitCoin and pleading guilty to parallel criminal charges. The company itself faced a setback when the Northern District of California denied its motion to dismiss, agreeing with the SEC’s Howey analysis.
In another pending federal action, the SEC sued tech magnate John McAfee in October 2020 for failing to disclose that he was paid millions to tout initial coin offerings on social media that were essentially worthless, Buchholz said. In March 2021, the Department of Justice brought parallel criminal proceedings against McAfee and his adviser. Buccholz noted that the CFTC has also sued McAfee for his involvement in the digital assets pump-and-dump scheme.
View from the defense bar. Panel moderator Sean Prosser of Mintz Levin asked John Berry, a partner at Munger, Tolles & Olson LLP, how a defense team should approach government investigations involving cryptocurrencies and digital assets. According to Berry, five years ago, government agencies had a good argument that most players in the crypto space were not legitimate, but things have changed since then. "The adults are in the room now," Berry said, and cryptocurrency has become a legitimate financial vehicle. However, there is still tension because the government tends to see it as a place where bad actors operate, he remarked.
Berry said that while the government still brings cryptocurrency cases against fraudulent practices, there are now more where the enforcement action hinges on technical regulatory violations. He drew attention to enforcement actions against the operator of cryptocurrency platform BitMEX by both the DOJ and the CFTC as an example. In the criminal complaint, the DOJ alleged that BitMEX violated the Bank Secrecy Act by willfully failing to establish and maintain an adequate AML program. The CFTC’s complaint charged the operator with operating an unregistered trading platform and violating market integrity and customer protection regulations under the Commodity Exchange Act.
Berry also criticized the use of old law to govern the new and complex area of crypto space, noting that Howey was decided in the 1940s and involved orange groves. Buchholz defended the Howey test for investment contracts, explaining that no one is claiming that an orange is a security; Howey involved how a product was packaged as an investment contract, which can happen with literally anything, he advised.
Michael Dicke of Fenwick & West commented on crypto-related actions brought by the Treasury Department’s Office of Foreign Assets Control (OFAC), which usually targets terrorists and drug lords. OFAC has settled charges against BitGo for violating international sanctions because individuals in the Crimea region of Ukraine, Cuba, Iran, Sudan, or Syria were using BitGo’s non-custodial secure digital wallet management service. In another settled action against a cryptocurrency platform, OFAC alleged that BitPay allowed its payment processing services to be used by individuals in sanctioned regions even though BitPay had location information about those persons prior to effecting the transactions, Dicke said.
The panelists also discussed recent litigation against Ripple Labs and its digital asset XRP. The SEC has alleged that Ripple and two executives raised over $1.3 billion through an unregistered, ongoing digital asset securities offering. While he was unable to comment on the pending litigation, Buchholz advised that the SEC is using the same Howey investment contract strategy that has been successful for the enforcement program in other recent litigation relating to cryptocurrency.
Berry was more skeptical that the SEC would be as successful in its case against Ripple. He noted that XRP is a token that has been around since 2013 and resembles another cryptocurrency, Ether. The founders of Ether used the token to raise money to build its platform and now Ether can be used to buy goods and services like Bitcoin. Berry noted that the SEC has not brought a case against Ether. He advised that the SEC will point out differences between Ether and Ripple, such as explaining that Ripple marketed its XRP token as an investment and that its founders made money selling it, as well as it not being as decentralized as Bitcoin or Ether. However, Berry remarked that with a currency token like XRP that has been used since 2013 to buy goods and services, it is a tougher argument that it is an investment contract under Howey.