After months of steadily increasing supervisory activity in regard to the emerging cryptocurrency sector, it now appears that U.S. financial market regulators may have switched gears and entered the enforcement stage.
The Securities and Exchange Commission (SEC) recently launched an industry sweep, serving a series of subpoenas and information requests to investment funds, advisers and technology companies participating in virtual currency transactions, such as initial coin offerings (ICOs), The Wall Street Journal reports. Moreover, officials have indicated they expect more to come. The New York Times has reported that the subpoenas demanded “a wide array of information about the virtual currencies they have sold, including the information used to market the digital tokens and the identity of the investors who bought them.” Other sources have estimated that as many as 80 companies and individuals were served with subpoenas or otherwise contacted as part of the SEC probe, and the move prompted several companies to pause their offerings after the agency raised questions regarding the transactions. The SEC itself has not publicly commented on the specifics of the subpoenas.
Industry sweeps typically occur when the SEC believes that the practices of a given industry may violate the securities laws. In an industry sweep, SEC enforcement staff may subpoena broad swaths of information designed to determine if the subpoenaed entity, a competitor or the industry more broadly has committed securities violations. As is the case with other large government investigations, industry sweeps, in particular, are organic; they can focus on different targets at different times, making sucessful navigation of them challenging. Industry sweeps can also graduate, if warranted, from regulatory inquiries to criminal investigations. While SEC officials have previously said that some cryptocurrency offerings qualify as securities transactions and therefore must comply with all relevant regulations, the financial markets regulator has not issued formal guidance on the matter.
The SEC’s enforcement sweep is the latest development in a pattern of escalating regulatory interest in virtual currencies and ICOs. For months, the SEC has publicly reiterated its interest in regulating ICOs specifically and the cryptocurrency markets in general. For example, on Feb. 6, 2018, SEC Chairman Jay Clayton and CFTC Chairman Christopher Giancarlo jointly testified before the Senate Banking Committee to discuss the regulatory oversight of cryptocurrencies, where they highlighted their efforts to identify the proper balance between protecting investors against manipulation and fraud while also encouraging innovation in the rapidly growing sector. During that hearing, Chairman Clayton explained that although no ICOs had registered with the SEC, “I believe every ICO I’ve seen is a security ... You can call it a coin, but if it functions as a security, it is a security.”
This was not Chairman Clayton’s first shot across the bow. During a speech in January, he explained that “Market professionals, especially gatekeepers, need to act responsibly and hold themselves to high standards. To be blunt, from what I have seen recently, particularly in the initial coin offering (ICO) space, they can do better.” He further criticized the actions of certain gatekeepers as “contrary to the spirit of our securities laws and the professional obligations of the U.S. securities bar,” later adding that “[t]hose who engage in semantic gymnastics or elaborate re-structuring exercises in an effort to avoid having a coin be a security are squarely in the crosshairs of our enforcement provision.”
In addition to Chairman Clayton’s comments, the transactions were highlighted when both the SEC and the Financial Industry Regulatory Authority (FINRA) released their respective examination priorities for 2018. This came after the virtual currency market grew exponentially in 2017, when all-time cumulative ICO funding surged from $295.45 million to $5.86 billion by the end of 2017. Inevitably, this growth prompted global regulators to take tentative steps to adapt to the unique challenges created by virtual currencies, which previously largely existed and operated outside the traditional financial systems.
Funds and advisers taking part in cryptocurrency transactions should take note of the SEC’s enforcement sweep. After news of the industry sweep broke, SEC Enforcement Division Co-director Stephanie Avakian added that the SEC is “very active, and I would just expect to see more and more.” And with a personal promise from Chairman Clayton that “[t]he SEC is devoting a significant portion of its resources to the ICO market,” the SEC has made it abundantly clear that the issuance of subpoenas and information requests is a sign that the SEC is ratcheting up its already active enforcement of the growing ICO market.
As is the case with other enforcement reviews, it is almost certain that the SEC’s inquiry will be rigorous and lengthy and is something that this burgeoning industry will have to reckon with for the foreseeable future.