In April, we continued to see a steady pace in the seriousness and frequency of crypto enforcement actions by state and federal law enforcement. (See our March 2022 Crypto Enforcement Actions Roundup blog here where we discuss the regulatory guidance and jurisdiction of federal and state agencies to enforce these matters.)
Sec Enforcement Priorities
On April 4, 2022, SEC Chair Gary Gensler outlined the SEC’s enforcement priorities as they relate to blockchain and cryptocurrencies in a speech at the Penn Law Capital Markets Association Annual Conference. Gensler’s comments addressed the SEC’s new approach to cryptocurrency trading platforms, stablecoins, and crypto tokens and leave no doubt that the Chair views the industry at large as falling well within the Commission’s purview.
Gensler’s comments suggest that the SEC may prioritize enforcement actions against trading platforms over individual tokens, noting that “[w]hile each token’s legal status depends on its own facts and circumstances, given the Commission’s experience with various tokens that are securities, and with so many tokens trading, the probability is quite remote that any given platform has zero securities.”
Gensler’s aim is to enforce registration requirements and other regulations against trading platforms. To that end, he has asked Commission staff to “work on a number of projects related to the platforms,” including:
- Getting the platforms registered and regulated like exchanges, and whether and how the protections that are afforded to retail investors on traditional exchanges should also apply to crypto platforms;
- Regulating platforms that list both crypto commodity tokens and crypto security tokens by working with the Commodity Futures Trading Commission (CFTC) to consider how best to register and regulate such platforms;
- Managing and administering crypto custody, a common practice on crypto exchanges, and whether to require segregation of custody and other market-making functions.
Stablecoins and Other Tokens
Gensler called out stablecoins as raising three sets of policy issues, including:
- Their impact on financial stability and monetary policy;
- Their potential for abuse involving illicit activity by offering a means of avoiding or deferring an on-ramp or off-ramp with the fiat banking system; and
- Market integrity and investor protection concerns stemming from conflicts of interest that arise when the stablecoins traded on a platform are owned by the platform itself and the customers end up in an undisclosed counterparty relationship with the platform.
Speaking on tokens generally, Gensler reiterated his—and his predecessor Jay Clayton’s—position that a scant few, if any, crypto tokens are not securities contracts under the Howey test. Summing this up, Gensler observed that, in the current environment, “many entrepreneurs are raising money from the public by selling crypto tokens, with the expectation that the managers will build an ecosystem where the token is useful and which will draw more users to the project.”
Gensler concluded with a renewed invitation to the blockchain and crypto industry to work with the SEC to register these tokens, even stating, “[i]f there are, in fact, forms or disclosure with which crypto assets truly cannot comply, our staff is here to discuss and evaluate those concerns.” Given the SEC’s spotty track record of working with token issuers attempting to register, many in the industry may take Gensler’s invitation to work cooperatively with the SEC with a large grain of salt.
State Enforcement Activities
State lawmakers also made enforcement waves this month, with regulators in New York, Texas, and Alabama targeting crypto companies with new legislation, and enforcement actions.
The forgoing OCC order mirrors actions taken by state regulators in New York, where the Manhattan District Attorney recently indicted a Bitcoin ATM operator for failing to collect and maintain customer identifying information and operating without a money transmission license from the New York State Department of Financial Services or Treasury’s Financial Crimes Enforcement Network.
In addition, New York lawmakers proposed a new bill this month aimed at cracking down on crypto fraudsters. Senate Bill No. 8839 targets deceptive and fraudulent practices which utilize digital assets. In particular, the bill criminalizes a specific type of crypto fraud scheme, known as a “rug pull,” in which a developer promotes a token to the public, only to quickly unload her own tokens and quit the project once the price has gone up. However, the proposed bill drops the abandonment component of the scheme, instead defining a “rug pull” as the act of a developer developing a class of virtual tokens, owning more than ten percent of the supply of such class of virtual tokens, and selling more than ten percent of the total supply of such class of virtual tokens within a five-year period from the date of the last sale of the same . . . .
By eliminating the abandonment requirement, SB 8839 would arguably create an onerous per se violation whenever a developer sold more than 10% of a token class.
Texas and Alabama
Meanwhile, the Texas State Securities Board and Alabama Securities Commission both issued cease-and-desist orders against individuals selling NFTs to fund the creation of metaverse casinos. The orders claim that the membership NFTs sold by the developers were in fact unregistered securities because the benefits to NFT holders included a pro-rata share of profits generated in the metaverse casinos. The developers also promised purchasers of the NFTs that they would receive anywhere between $100 and $6750 dollars per month in shared profits from the online casinos, depending on the level of NFT purchased. The Texas order is particularly scathing, calling out the defendants not only for the unregistered offering, but also for allegedly misleading the public:
Although the NFTs constitute securities, Respondents are advising purchasers that securities laws do not currently regulate NFTs and are considering further steps to obstruct the regulation of their NFTs. . . . The advice regarding regulation is simply not true and the offering of NFTs is a high-tech scam. The parties are concealing their locations, hiding the identities of managers, misleading potential purchasers about their experience, and obscuring the significant risks associated with investing in their NFTs.
While this appears to be a more egregious case, it does confirm our prediction last month that regulators at all levels are moving forward in earnest against NFT and other more novel token companies where they believe a violation has occurred.
The crypto-regulatory and enforcement landscape remains a convoluted patchwork. There are many legal considerations involving NFTs, crypto, and other Web3 technologies. What is not murky, however, is the clear stance by U.S. regulators that, notwithstanding the novelty of the technology and asset class, basic principles still apply: registered or not, developers, protocols, projects and platforms can’t defraud retail investors; they can’t aid and abet money laundering; and they can’t violate sanctions. Stay tuned for next month’s installment of the crypto roundup.