Recently, the U.S. Securities and Exchange Commission reasserted its claim of regulatory authority over digital currencies when it charged an individual and his two companies with violating federal securities laws in connection with initial coin offerings (ICOs). Combined with other recent SEC actions and initiatives, these cases illustrate the SEC’s effort to stake its claim as a leading regulator of digital currencies.
Recent SEC Enforcement Actions
On Sept. 29, 2017, the SEC charged Maksim Zaslavskiy and two of his companies, RECoin Group Foundation and Diamond Reserve Club, with violations of the securities laws relating to the offering of digital coins or tokens. The SEC alleged that Zaslavskiy, RECoin and Diamond made several misrepresentations in connection with their offering. For example, prospective investors were told that the coins offered by RECoin and Diamond were backed by real estate and diamonds, respectively, and that the companies had a team of professionals, including lawyers, brokers and accountants, to invest in real estate and diamonds. Further, investors were told they could expect to receive 10 to 15 percent returns from their investments and that the companies had already raised $2 million (and later $4 million).
The SEC charged Zaslavskiy, RECoin and Diamond with making material misstatements and/or omissions under Section 10(b) of the Exchange Act, violating the anti-fraud provisions of Section 17(a) of the Securities Act, and failing to register the securities that were being offered, in violation of Sections 5(a) and 5(c) of the Securities Act. In addition, the SEC charged Zaslavskiy with aiding and abetting the securities laws violations by his companies. The case is currently pending in federal court.
The action against Zaslavskiy, RECoin and Diamond builds upon the SEC’s recent focus on the application of federal securities laws to digital currencies. In July 2017, the SEC issued a report regarding its investigation into The DAO, which, like RECoin and Diamond, involved the offering of digital tokens to investors. While declining to pursue an enforcement action against The DAO, the SEC’s report described how existing U.S. federal securities laws applied to new and developing technologies in capital markets, including distributed ledger technology, known as blockchain, and initial coin offerings. Significantly, the SEC determined that the tokens offered by The DAO were “securities” or “investment contracts” subject to federal securities laws, and that those securities must be registered in connection with a public offering.
Following the report on The DAO, in August 2017, the SEC requested that Protostarr voluntarily disclose information in connection with its ICO, which raised $47,000 in July 2017. Protostarr had not consulted with any lawyers prior to its ICO and, after receiving the SEC’s request, decided to shut down operations and refund contributions from investors. To date, the SEC has not initiated an enforcement action against Protostarr or any members of its management.
The enforcement action against Zaslavskiy, RECoin and Diamond firmly establishes the SEC’s assertion of authority over digital currencies. But it is important to note that the SEC’s recent foray into digital currencies is not the first assertion of regulatory authority in the digital currency arena. That distinction belongs to the U.S. Commodity Futures Trading Commission, which first claimed jurisdiction over digital currencies nearly two years ago when it deemed them to be “commodities.” The CFTC has continued to be active in this space. Eight days before the SEC’s actions against Zaslavskiy, RECoin and Diamond, the CFTC announced its first anti-fraud enforcement action, charging a company and its CEO with operating a Bitcoin Ponzi scheme that solicited more than $600,000 from investors for placement into a pooled commodity fund. The CFTC also alleged that the defendants sought to further their fraud through misleading representations and conceal their misappropriation of investor funds through false performance reports.
While the U.S. Department of Justice and state regulators might seek to prosecute fraud related to digital currencies through mail fraud, wire fraud or other statutes, the SEC’s and CFTC’s recent anti-fraud enforcement actions establish them as regulatory leaders in the digital currency marketplace. Critical to the success of each agency’s regulatory efforts is whether courts agree that digital currencies are “securities” or “investment contracts” (as the SEC asserts) or “commodities” (as the CFTC asserts). Notably, the analysis underlying these conclusions differs greatly. As illustrated in the SEC’s report of investigation of the DAO, the SEC has taken an incremental approach to its jurisdiction, classifying digital currencies as “securities” based on the facts and circumstances of a particular case, therefore leaving open the possibility that some digital currencies might not be subject to federal securities laws. The CFTC, on the other hand, has taken a broader view, asserting that all “Bitcoin and other virtual currencies are encompassed in the definition [of commodity] and [are] properly defined as commodities.” Courts have not yet weighed in on either proposition, but pending federal court cases involving both the SEC and CFTC may address these issues.
As recent enforcement actions play out in court, industry participants are likely to see increased regulatory activity in the coming years. In particular, the SEC has spent several years studying blockchain and other developing technologies in capital markets through its Distributed Ledger Technology Working Group, culminating in the SEC’s recent announcement regarding the creation of a cyber unit, which will focus, among other things, on violations involving blockchain and ICOs. Steven Peikin, co-director of the SEC’s Division of Enforcement, recently predicted increased enforcement activity relating to digital currencies, with investigations likely to focus on firms involved with fraudulent ICOs, firms selling unregistered digital currencies, and firms and individuals that sell digital currencies without appropriate broker-dealer registration. Further, SEC Chairman Jay Clayton alluded to greater enforcement activity when he recently said that he is concerned about the potential for pump-and-dump schemes in ICOs and their effects on retail investors.
Corporate investors in digital currencies may also be impacted by the SEC’s increased focus on digital currencies. Recently, the SEC has issued orders suspending the trading in securities of publicly traded investment firms based on questions about those companies’ public disclosures relating to digital currencies. In some instances, those questions related to the role of digital currency in a company’s business, the use of blockchain technology, or ICOs. But the SEC has also issued trading suspension orders based on concerns about how a public company’s digital currency investments affect traditional concerns about liquidity, valuation of assets, and capital structure. In 2017 alone, the SEC has issued five trading suspension orders related to digital currencies, each of which likely resulted in substantial costs to those issuers. In addition, enhanced scrutiny of a company’s public disclosures on digital currencies could lead to further scrutiny of public disclosures on other topics, as well as potential financial and reputational costs associated with SEC scrutiny.
The SEC’s recent enforcement actions relating to digital currencies represent a substantial step toward establishing the SEC as a leading regulator of digital currencies. While other regulators, particularly the CFTC, may seek to claim that same mantle, SEC enforcement relating to digital currencies shows no signs of slowing down. In particular, public companies and registered investment advisers that invest in digital securities may be the subject of additional SEC scrutiny, and must carefully consider their public disclosures relating to digital currencies.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 Complaint, SEC v. RECoin, No. 17-5725 (S.D.N.Y. Sept. 29, 2017).
 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, SEC Release No. 81207, July 25, 2017.
 Grant Fondo et al., SEC’s Phone Call to Protostarr Shuts Down its ICO, Sept. 6, 2017, https://www.goodwinlaw.com/publications/2017/09/secs-phone-call-to-protostarr-shuts-down-its-ico.
 In re Coinflip Inc., No. 15-29 (C.F.T.C. Sept. 17, 2015).
 CFTC v. Gelfman Blueprint, No. 17-7181 (S.D.N.Y. Sept. 21, 2017).
 Press Release, No. 2017-176, SEC Announces Enforcement Initiatives to Combat Cyber-Based Threats and Protect Retail Investors, Sept. 25, 2017.
 Debevoise & Plimpton LLP, Client Update: SEC Leadership Discusses Continuing Priorities, Sept. 8, 2017, https://www.debevoise.com/~/media/files/insights/publications/2017/09/b20170908_sec_leadership_discusses_continuing_priorities.pdf.
 Benjamin Bain, ICO Market is Probably Full of Fraud, U.S.’s Top Financial Cop Warns, Bloomberg.com, https://www.bloomberg.com/news/articles/2017-09-28/u-s-s-top-financial-cop-warns-ico-market-probably-full-of-fraud.
 In the Matter of Strategic Global Investments Inc., Order of Suspension of Trading, Aug. 3, 2017; SEC Release No. 81367, Aug. 9, 2017; SEC Release No. 81481, Aug. 24, 2017.
 In the Matter of Sunshine Capital Inc., Order of Suspension of Trading, April 11, 2017; see SEC Release No. 81474, Aug. 23, 2017.