On October 5, 2018, the Securities and Exchange Commission (“SEC”) obtained a temporary restraining order (“TRO”), halting a planned initial coin offering (“ICO”) by a San Diego based company (the “Company”) and its owner in December 2018. Judge Gonzalo P. Curiel, of the U.S. District Court for the Southern District of California, issued the Order, which also froze defendants’ assets, ordered an accounting, and granted expedited discovery. SEC v. Blockvest, LLC, et al., No. 3:18-cv-02287 (S.D. Cal Oct. 5, 2018) (the “Order”). The grounds for this Order included that defendants falsely claimed that the ICO was approved by the SEC and other regulators and that they were audited by a reputable third party firm. A preliminary injunction hearing is set for October 18, 2018. In addition to obtaining the Order, the SEC also filed a Complaint against defendants on October 3, 2018, alleging violations of the antifraud provisions of Section 17(a) (1-3) of the Securities Act of 1933 and Section 10(b) and Rule 10b-5(a-c) of the Securities Exchange Act of 1934, as well as the securities offering registration provisions of Section 5(a) and (c) of the Securities Act. Complaint, SEC v. Blockvest, LLC, et al., No. 3:18-cv-02287 (S.D. Cal Oct. 3, 2018).
According to the Complaint filed by the SEC, the Company conducted pre-sales of their digital assets (known as BLVs) in March 2018 and falsely claimed that it was the “first licensed and regulated tokenized Crypto Currency Exchange & Index Fund based in the US.” The Complaint also cited other alleged false statements by defendants, including that the ICO and its affiliates received regulatory approval from the SEC, the CFTC, and the National Futures Association (“NFA”). In fact, the NFA previously issued a cease-and-desist letter to the Company, directing it to stop falsely claiming or implying membership with, or regulation by, the NFA. The Complaint also alleged that the owner promoted the ICO with a fake agency he created called the “Blockchain Exchange Commission,” using a graphic similar to the SEC’s seal and the same address as SEC headquarters. In addition, the defendants allegedly misrepresented that the Company “partnered” with, and was “audited by,” a large accounting firm, which has no association with the Company.
Although the ICO was not scheduled until December 2018, the SEC sought and obtained the TRO since the defendants were planning on attending events in mid-October that were aimed at promoting and seeking commitments for the December 2018 ICO. And while the status of cryptocurrencies remains a hot-button issue, it appears that defendants conceded that this ICO would need to be registered as a securities offering since they purported to rely on Securities Act Regulation D (Rule 506) for the offering, and claimed that the ICO would be made to accredited investors; in public statements, however, defendants also claimed that they could rely on Securities Act Regulation A. The SEC took issue with this characterization and defendants’ efforts to ensure that they were targeting only accredited investors, which formed a basis for its Section 5 claim.
The Court nonetheless found that the cryptocurrency at issue was a security, noting, among other things, that “[d]efendants also characterized the BLVs as securities by filing a Form D with the SEC, claimed to have qualified for a Regulation A exempt securities offering; and publically stated in marketing and promotional materials that they have complied with the securities law.” (Order at 8-9.) The Court also emphasized that the purpose of the ICO was to raise money for defendants and that investors were interested in generating “passive income,” which also supported the conclusion that the digital assets at issue (BLVs) were securities.
In finding a likelihood of success on the fraud-based claims, the SEC cited the litany of alleged false statements cited above. Specifically, the Court found that the “use of the SEC and CFTC’s seals and the logos of the NFA and the accounting firm create a false appearance of legitimacy for the ICO.” (Order at 10.)
The case is another sign of U.S. regulators’ focus on the cryptocurrency space and ICOs in particular. We have previously reported on a number of enforcement actions in this space, and this is another decision in which a federal court found that cryptocurrencies are securities. See Shearman & Sterling LLP, District Of Massachusetts Denies Motion To Dismiss, Finds Virtual Currency “My Big Coin” Is A Commodity Under Commodity Exchange Act, Need-to-Know Litigation Weekly (October 9, 2018), Shearman & Sterling LLP, Significant Judicial And Enforcement Developments In The Cryptocurrency Space, Need-to-Know Litigation Weekly (September 18, 2018), Shearman & Sterling LLP, Criminal And Civil Charges Filed In Connection With Initial Coin Offering By Centra Tech, Need-to-Know Litigation Weekly (April 10, 2018)