*co-authored by Elizabeth L. Carter, Esq., Managing Attorney
The Securities and Exchange Commission (SEC) has been busy applying federal securities laws to the digital asset space which includes cryptocurrencies, initial coin offerings (ICOs), and non-fungible tokens (NFTs). A report by American Progress valued the digital space at around $1.95 trillion in mid-August which increased to $2.14 trillion in September, just one month later.
In addition to this growth, there have been several accounts of theft, fraud, and other violations by issuers and consumers of these digital assets. The digital asset space is decentralized and not largely regulated, which causes many participants to fall victim to fraudulent actors. Thus, it is up to regulators like the SEC to step in and hold violators accountable, especially where there are cases of investment fraud, unregistered securities, and market manipulations.
Cryptocurrency Exchange Platform
The SEC is specifically cracking down on cryptocurrency exchange platforms that were found to be defrauding investors. This includes BitConnect, a cryptocurrency exchange platform that is facing litigation for allegedly defrauding thousands of investors of $2 billion. The SEC is charging BitConnect with misrepresenting its ability to generate profits through its “Lending Program”, and for failing to register its offering with the agency (it is not clear whether BitConnect’s offering was eligible for an exemption from registration such as a crowdfunding exemption).
BitConnect’s founder Satish Kumbhani and promoter Glenn Arcaro are both being charged. Kumbhani allegedly lied to investors about the platform’s ability to generate profits and Arcaro fraudulently received “referral commissions” of more than $24 million. The SEC aims to “impose fines, recoup ill-gotten gains, and other relief” from both individuals. Based on the complaint filed by the SEC, BitConnect was an unincorporated organization and neither the founder, promoter, or company was registered with the SEC “as a broker-dealer or associated with a registered broker-dealer.”
Market manipulation can take place when an individual or business intentionally influences the behavior of the securities market. In the world of crypto, there are many instances where the price will suddenly increase with a sharp decline shortly after. The term “pump and dump scheme” was coined due to the frequency of these sudden increases and steep declines in stock prices.
Market manipulation was especially evident with the smaller cryptocurrencies companies. These smaller companies were easier to manipulate because they have smaller market value than the larger cryptocurrencies companies as well as and lower liquidity. This market manipulation is so easy that all a violator would have to do is place large buy or sell orders to either pump up the prices or bring them down. This causes other traders to quickly sell at a lower price out of fear that they will be left with worthless cryptocurrency. Pump and dump schemes are illegal and considered to be securities fraud by the SEC.
A casebook example of a pump and dump scheme in the digital asset space is with a former dentist who was charged with securities fraud for his control and ownership over Apis Capital Management LLC. Edgar Radjabli misled investors to purchase Apis Tokens which was called the “first tokenized hedge fund.” The tokens were supposedly a way for investors to access the ACM Market Neutral Volatility Strategy Fund (Fund). The idea was that investors would convert their Ethereum and Bitcoin into Apis Tokens in order to access the Fund. However, Radjabli misled investors into believing that $1.7 million had been raised and fraudulently announced that Apis Capital was buying an artificial intelligence (AI) division of blockchain called Veritone.
This made Veritone shares jump to 93% at $10.26. Meanwhile, Apis Capital had no intention of acquiring Veritone and in fact had no capital to do so. Radjabli allegedly made $162,800 in profit by trading his Veritone stock during this scheme. The SEC has since requested that the U.S. District Court mandate that Radjabli and Apis Capital pay $600,000 in damages. In addition, this request would characterize Radjabli as a “bad actor” and become disqualified from selling penny stocks and participating in the sale of securities entirely.
Initial Coin Offering
In the realm of initial coin offerings (ICOs), the SEC is holding platforms accountable for failing to disclose pertinent information to users. Initial coin offerings are generally used to raise capital in exchange for the use of a coin. Generally, promoters of ICOs will sell virtual coins or tokens to investors for their use on a soon-to-be developed digital platform, software, or some other offered project. Promoters also lead investors to believe that they will receive a return on investment from their purchase. This promise of a return on investment makes the ICO a security in need of SEC registration or SEC qualification from registering.
Coinschedule.com, an online website that lists ICOs, has settled charges with the SEC for violating “anti-touting” provisions. This website site would provide links to the website of an issuer of an ICO and provide scores that would rate the “credibility” and “operational risk” of the ICO. The website also charged issuers to list their ICOs. However, Coinschedule.com failed to disclose this information to their visitors. As a result, the SEC found that the company violated federal securities laws for anti-touting. The operator of Coinschedule.com agreed to pay $43,000 in disgorgement and a fine of $154,434. The company did not admit or deny the SEC findings but did agree to a “cease and desist” order to refrain from committing any anti-touting acts now and in the future.
It is important for digital-assets creators to seek counsel from competent securities lawyers if they plan to raise capital from investors to help finance the creation of these assets. The risky and speculative nature of digital assets coupled with SEC regulatory oversight can be extremely daunting for new creators and small businesses.
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