The SEC has continued to respond aggressively when it perceives that there have been violations involving blockchain technology or initial coin offerings (ICOs). For example, on January 5, 2018, the SEC temporarily suspended trading in shares of UBI Blockchain Internet, Ltd. over questions concerning the accuracy of assertions by the company with respect to business operations and concerns about recent market activity in the company’s common stock. The UBI action follows earlier trading suspensions of public companies that had promoted plans for future ICOs, such as First Bitcoin Capital Corp., CIAO Group, Strategic Global, and Sunshine Capital.
On August 28, 2017, the SEC published an investor alert warning that unscrupulous public companies may be taking advantage of recent public interest in ICOs to defraud investors. That alert cautions that certain companies making claims pertaining to an ICO or a potential ICO may, in fact, be fraudulent “pump-and-dump” schemes. In such schemes, fraudsters use false and misleading information to tout a company’s stock and then sell their stake for a profit before the share price collapses.
In September 2017, the SEC’s Division of Enforcement formed a “Cyber Unit” which includes staff from across the country. The Cyber Unit is designed to focus the SEC’s “cyber-related expertise” on “misconduct involving distributed ledger technology and initial coin offerings, the spread of false information on social media, hacking, and threats to trading platforms.”
In December 2017, the SEC announced the first enforcement action to come out of the Cyber Unit. In the press release (available here), the SEC described the PlexCoin ICO as a “fast-moving” fraud with “all of the characteristics of a full-fledged cyber scam.” The SEC sought and obtained an emergency asset freeze related to an initial coin offering by PlexCorps of a new digital cryptographic token, PlexCoin. According to the SEC, PlexCorps raised up to $15 million from thousands of investors since August and promised a profit yield for investors of 1,354 percent in less than 29 days.
The SEC complaint (available here) charges PlexCorps, its founder, Dominic Lacroix, and his business partner, Sabrina Paradis-Royer, with violations of (i) the anti-fraud provisions in Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and (ii) the registration requirement in Section 5 of the Securities Act of 1933. The complaint seeks permanent injunctions, disgorgement of profits (plus interest), and civil penalties, as well as an officer-and-director bar and a bar from participating in future offerings of digital securities against both Lacroix and Paradis-Royer.
The SEC has moved swiftly to enforce the federal securities laws in the context of digital currencies, even with respect to ICOs that did not involve fraud, such as the Munchee token action discussed in our recent client alert, available here. The creation of the Enforcement Division’s Cyber Unit and formation of a senior-level cybersecurity working group, both of which consider violations involving distributed ledger technology and initial coin offerings, provide a clear indication of the Commission’s focus on the emerging cryptocurrency market.
The PlexCoin case may also signal increased cooperation among regulators in the digital token space: the SEC’s press release explicitly thanked Quebec’s financial regulatory body, Autorité des Marchés Financiers (the “AMF”), for its assistance in the PlexCoin matter. The AMF itself had taken action related to the PlexCoin ICO.
Given the increased regulatory scrutiny, market participants seeking to create new blockchain-based businesses or to reorient existing businesses toward blockchain-based technologies will need to be thoughtful in their public statements and communications. Issuers and other market participants should also ensure that they fully consider and evaluate the impact of the federal and state securities laws, including any applicable registration provisions.