By Mark S. Nelson, J.D.
Among the factors fueling the ongoing uptick in SEC crypto enforcement actions is the agency’s focus on crypto firms whose products and services bear the hallmarks of lending platforms and has meant the SEC is more frequently citing Reves, a Supreme Court opinion defining when notes are securities, in additional to the Howey standard that has dominated SEC crypto enforcement previously. The latest such case involved Nexo Capital Inc., which agreed to pay the SEC $22.5 million and to pay multiple state jurisdictions over $24 million. Nexo settled the SEC’s charges without admitting or denying the agency’s findings (In the Matter of Nexo Capital Inc., Release No. 33-11149, January 19, 2023).
SEC Chair Gary Gensler remarked on the settlement via press release. “Compliance with our time-tested public policies isn’t a choice,” said Gensler. “Where crypto companies do not comply, we will continue to follow the facts and the law to hold them accountable.”
EIP product. According to the SEC, Nexo offered its Earned Interest Product (EIP) to U.S. investors. Investors would tender crypto to Nexo, which would then place the crypto in interest-bearing accounts and use the crypto to generate further profits, all the while paying interest to investors for the use of their crypto. There were flexible and fixed versions of the EIP in which “flexible” investors could make withdrawals of crypto and interest at any time, but “fixed” investors’ crypto and interest were locked-up for a stated period of time before they could be withdrawn.
The SEC’s order stated that, as of March 2022, Nexo had 3.7 million global users and $13.7 billion in global assets; U.S. investors numbered 112,000 and U.S. assets totaled $2.7 billion.
The SEC alleged that Nexo sold the EIP without a registration statement and without a valid registration exemption. The SEC also said the EIP constituted investment contracts and notes and, thus, were securities. Under the Supreme Court’s Reves opinion, notes are compared against products that are not securities and if a family resemblance between these two groups of products is lacking, the item in question may be a security. Here, the SEC emphasized that Nexo used investor funds for its lending operations and to pay interest to EIP investors, EIP was sold to a wide segment of the public, EIP was promoted as an investment, and there was no alternative to the SEC’s regulatory regime to oversee EIP.
The SEC made similar arguments to the effect that EIP investments also were investment contract and, thus, securities under the Supreme Court’s Howey opinion. Among other things, the SEC said EIP funds were pooled such that EIP investors’ fortunes rose/fell together; EIP funds also were deployed by Nexo for its own profit, so Nexo’s fortunes were likewise joined to those of EIP investors. Moreover, Nexo created a reasonable expectation that it would use its managerial and entrepreneurial efforts to generate profits for others.
Settlement terms. The SEC charged that Nexo violated Securities Act Sections 5(a) and 5(c) by engaging in the EIP program without a registration statement or valid registration exemption. The settlement, which Nexo entered without admitting or denying the SEC’s findings, requires Nexo to cease and desist from further similar violations of the federal securities laws and to pay a civil money penalty of $22.5 million.
A key driver of the settlement was that Nexo voluntarily began to shut down its U.S. operations in February 2022 after the SEC brough charges against a similar crypto scheme. By December 2022, the SEC said Nexo had stopped taking EIP investment in some states and planned to phase-out all U.S. products and services soon after April 1, 2023.
State settlement. Nexo also agreed to settle state charges brought by New York, California, Indiana, Kentucky, Maryland, Oklahoma, South Carolina, Vermont, Washington, and Wisconsin. Under the settlement, each member jurisdiction in the North American Securities Administrators Association may claim at least $424,000 of the total $22.5 million settlement. New York obtained an additional $1.5 million related to charges that Nexo offered and sold unregistered securities on its Nexo Exchange, bringing New York’s total recovery to $1.9 million, and the total state settlement amount to more than $24 million.
For its part, Nexo must pay a combined fine of $24 million to resolve the state charges. In New York, for example, Nexo also will be subjected to a five-year securities industry bar and the company must tell its EIP investors to withdraw their funds by April 1, 2023. Nexo also must segregate investor funds and cannot use them for speculative activities.
New York Attorney General Letitia James addressed via press release the notion that crypto firms are above the law. “Nexo ignored repeated warnings by my office to register and today they are paying the price for their wrongdoing,” said James. “The days of crypto companies acting like the rules do not apply to them are ending.”
The release is No. 33-11149.