Agencies Issue Multiple Digital Asset-Related Enforcement Orders
09/20/2018The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) last week issued three digital asset-related enforcement orders, and the SEC also suspended trading in two securities that track the value of digital assets. The orders mark an uptick in digital asset enforcement from previous months and suggest that regulators and self-regulatory organizations are still keeping a close eye on the nascent digital asset investment industry.
Crypto Asset Management, LP
On September 11, 2018, the SEC alleged that hedge fund manager Crypto Asset Management (CAM) had caused its Crypto Asset Fund (CAF) to fail to register as an investment company based on its digital asset investments, marking the first time the SEC has invoked the Investment Company Act of 1940 (the 1940 Act) in an enforcement proceeding against the managing member of a pooled investment vehicle that invests in digital assets.
The settlement order alleged that CAM and its sole principal Timothy Enneking raised over $3.6 million for CAF from 44 investors from August 1, 2017 through December 1, 2017, including through general solicitation and through false statements that the fund was regulated by the SEC and had filed a registration statement with the agency. Additionally, the SEC alleged that CAF operated as an unregistered investment company by engaging in an unregistered non-exempt public offering and investing more than 40 percent of the fund’s assets in digital asset securities. The 1940 Act defines an investment company to include an issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 percent of its total assets (exclusive of government securities and cash items) on an unconsolidated basis. The SEC alleged that the digital assets in which CAF invested were securities, and that CAF thus fell within the definition of an investment company.
Without admitting or denying the SEC’s findings, CAM and Enneking agreed to the agency’s cease-and-desist order and censure, and agreed to pay a $200,000 fine. The order also indicates that CAM made a rescission offer to the affected investors to address the fact that the securities they had purchased in CAF had been unregistered.
Also on September 11, 2018, the SEC filed and settled charges against TokenLot LLC and its owners for acting as unregistered broker-dealers. This is the SEC’s first disciplinary action charging an unregistered broker-dealer for selling digital tokens.
The SEC alleged that TokenLot, Lenny Kugel and Eli L. Lewitt promoted TokenLot’s website as a means of purchasing digital tokens during initial coin offerings (ICOs) and selling those tokens in secondary markets. Through these efforts, TokenLot received orders from more than 6,100 retail investors and handled more than 200 digital tokens. The SEC found that because the digital tokens issued in the ICOs and traded by TokenLot, Kugel and Lewitt included securities, their activities required broker-dealer registration with the SEC. As a result, the SEC concluded that TokenLot, Kugel and Lewitt effected unregistered securities transactions as unregistered broker-dealers in violation of Section 15(a) of the Securities Exchange Act of 1934, as amended (the 1934 Act) and Sections 5(a) and (c) of the Securities Act of 1933 (the 1933 Act).
In response to the SEC’s investigation, TokenLot voluntarily wound down its business and refunded customers for unfilled orders. In addition, TokenLot, Kugel and Lewitt agreed to pay $478,929 in disgorgement and retain an independent third party to destroy TokenLot’s remaining digital assets. Kugel and Lewitt also each agreed to pay $45,000 fines and agreed to industry and penny stock bars, along with an investment company prohibition with the right to reapply after three years.
Timothy Tilton Ayre and HempCoin
In what we believe is FINRA’s first-ever disciplinary action related to digital assets, FINRA on September 11, 2018 filed a complaint charging Timothy Tilton Ayre with securities fraud and the unlawful distribution of an unregistered digital asset security called HempCoin.
FINRA alleged that from January 2013 through October 2016, Ayre solicited public investment in his firm Rocky Mountain Ayre, Inc. (RMTN) by issuing and selling HempCoin and publicizing HempCoin as the “first minable coin backed by marketable securities.” Ayre then allegedly repackaged HempCoin as a security backed by RMTN common stock in 2015, and then proceeded to market HempCoin as “the world’s first currency to represent equity ownership” in a publicly traded company and sell the coins on the basis that each coin was equivalent to 0.10 shares of RMTN common stock. FINRA has charged Ayre with the unlawful distribution of an unregistered security as a result of his failure to register HempCoin as a security or seek an exemption.
Further, FINRA alleged that Ayre defrauded investors by making materially false statements and omissions regarding the nature of RMTN’s business, failing to disclose his creation and unlawful distribution of HempCoin and making false statements related to the firm’s financial health.
The complaint represents an initiation of formal proceedings by FINRA. Under FINRA rules, Ayre may file a response and request a hearing before a FINRA disciplinary panel. If found to have committed the alleged violations, possible remedies include a fine, censure, suspension or bar from the securities industry, disgorgement or payment of restitution.
XBT Provider AB
On September 9, 2018, the SEC temporarily suspended trading in Bitcoin Tracker One (Ticker Symbol: CXBTF) and Ether Tracker One (Ticker Symbol: CETHF), two securities listed on the Nasdaq Stockholm exchange by XBT Provider AB, a Swedish issuer of digital asset tracking certificates. In its suspension order, the SEC cited confusion amongst market participants due to a lack of current, consistent and accurate information in regulatory filings for the securities. For example, the SEC noted that broker-dealer application materials submitted to permit the offer and sale of CXBTF and CETHF in the U.S. described the securities as “Exchange Traded Funds,” while other materials described them as “Exchange Traded Notes.” However, in its offering materials, XBT Provider characterized the securities as “non-equity linked certificates.”
Trading in the securities is suspended until 11:59 p.m. EDT on September 20, 2018. The SEC in its suspension order did not specify whether any steps must be taken by XBT Provider to resume trading in CXBTF and CETHF.
These enforcement actions suggest that the SEC and FINRA are turning up the heat on sponsors, sellers and purchasers of digital assets with respect to compliance with the applicable provisions of the 1940 Act, the 1933 Act and the 1934 Act, including corresponding registration and disclosure requirements. Going forward, market participants should continue to monitor whether certain digital assets are securities and whether their digital asset activities trigger registration requirements.