On March 27, 2018, Massachusetts' top securities regulator – the Massachusetts Securities Division (the Division) – propelled itself to the forefront of the ongoing debate about whether "initial coin offerings" (ICOs) should be regulated like other, more traditional securities. In a coordinated effort clearly designed to send a message that the Division intends to closely regulate ICOs, the Division issued five consent orders and stopped the sale of more than 1.3 billion coins and tokens in the Commonwealth, which their issuers intended would raise tens of millions of dollars.1
Secretary William Galvin, who heads the Division, has not shied away from this emerging enforcement arena. In December, the Secretary proclaimed that "there is little question that the offer and sale of the digital coins are securities which need to be registered or exempt from registration in the Commonwealth."2 He warned that "ICOs are fodder for scam artists trying to capitalize on the craze," and that the "Securities Division intends to patrol [ICOs] to proactively prevent investor harm."3 According to Secretary Galvin: "No one regulator can police this marketplace."4 Less than a month later, on January 17, 2018, Secretary Galvin filed his first action before the Division seeking to enjoin an ongoing ICO for a Cayman Islands company by the name of Caviar.5
The Secretary is not alone. Securities regulators have hurried in recent months to respond to the explosion of ICOs. On February 6, 2018, Securities and Exchange Commission Chairman Jay Clayton testified before the Committee on Banking, Housing and Urban Affairs that "[w]hen investors are offered and sold securities – which to date ICOs have largely been – they are entitled to the benefits of state and federal securities laws and sellers and other market participants must follow these laws."6 Chairman Clayton also testified that he had "asked the SEC's Division of Enforcement to continue to police these markets vigorously and recommend enforcement actions against those who conduct ICOs or engage in other actions relating to crypto currencies in violation of the federal securities law."7
The Division's flurry of activity should capture the attention of anyone contemplating opening an ICO to Massachusetts residents, as they may soon find themselves in the Division's regulatory crosshairs. Indeed, the Division has now brought actions against companies ranging from an "advertising and analytics social television firm" (Across Platforms) to a creator, producer and distributor of children’s programming (18moons). If, indeed, token sales constitute securities, those offering them – no matter what they do or sell – must adhere to myriad processes, disclosures and other investor protections set forth in Massachusetts' securities laws. Those issuers, most likely unfamiliar with the Division, may find themselves asking what it is, what authority it has to regulate the space and what to do when a subpoena arrives at their door. This article provides an overview of the Securities Division, its jurisdiction and enforcement powers.
The Division’s mandate
The Division's authority comes from Massachusetts General Laws chapter 110A, the Uniform Securities Act, which empowers the Secretary to regulate the offer and/or sale of securities in Massachusetts and to police securities fraud. Pursuant to the Act, the Secretary also promulgates additional regulations, located in 950 Code of Massachusetts Regulations 10.00 et seq.
For the Division to have jurisdiction, there must be at least some connection to Massachusetts. For example, the Act provides that an offer to sell or to buy is made in Massachusetts, "whether or not either party is present in [Massachusetts], when the offer (1) originates from [Massachusetts] or (2) is directed by the offeror to [Massachusetts] and received at the place to which it is directed …."8 In each of the March 27 orders and the Caviar matter the defendants were present in Massachusetts, had a principal place of business in Massachusetts, or had operations in Massachusetts.9
Even for those not based in Massachusetts, purposefully excluding Massachusetts investors may not be enough to avoid the Division’s scrutiny. For example, the complaint in the Caviar matter states that, in sworn testimony before the Division, Caviar’s majority partner claimed that the company had attempted to exclude United States investors from the ICO's target audience and that it later "applied, or caused to be applied, a filter to exclude US-based IP addresses from accessing the Caviar [w]ebsite."10 While typically such efforts are enough, at least in matters before the SEC, to avoid scrutiny, the Caviar complaint demonstrates that the Division takes a broader view of its enforcement powers.
The Division’s enforcement authority
The Division's Enforcement Section conducts public and private investigations concerning violations or potential violations of the Act and, "[w]hen warranted, the Enforcement Section brings administrative proceedings to prevent future infractions and seeks redress for prior violations of the Act."11 The Enforcement Section’s investigatory powers are broad. For example the Act authorizes the Secretary to subpoena witnesses to provide testimony or documents, and to compel their compliance so long as "the [S]ecretary deems [it] relevant or material to the inquiry."12 Recipients of such subpoenas may attempt to quash them, but courts are constrained in their ability to do so unless the subpoena exceeds the Secretary’s jurisdiction or is meant to harass the recipient.13
In recent months, the Enforcement Section has flexed its regulatory might and moved increasingly faster to quash unregistered ICOs to Massachusetts residents. In each of the five matters settled on March 27, for example, the Secretary had issued subpoenas or inquiry letters between January 25, 2018 and February 5, 2018. They were each settled less than eight weeks later. By contrast, the 23-page complaint in the Caviar matter details the Division's five month-long investigation, beginning in September 2017.
The Caviar complaint, and several of the March 27 orders, also demonstrate that the Enforcement Section is willing to take somewhat unconventional means to police the area, including by monitoring social media. The Caviar complaint, for example, discusses how Division employees created fake social media profiles to test the ICO's ability to screen out US investors (which apparently failed), on one instance "using the name of a popular cartoon character."14 The complaint also notes that at least one Division employee took note of sponsored advertisements for the ICO "on his personal Instagram feed, and captured screenshots of four such advertisements," and that the Division reviewed "interviews on multiple podcasts and YouTube videos” given by the promoter of the ICO.15
Adjudicatory proceedings before the Division
Generally, the Division initiates an action by filing an administrative complaint in an adjudicatory proceeding conducted before a Presiding Officer, which may be the Director of the Division or an appointee.16 Upon commencing the proceeding, or anytime thereafter, the Division may request that the Presiding Officer issue a temporary order to cease and desist. The Division may do so ex parte if the Secretary demonstrates "irreparable harm to the public interest which would result if such an order were not issued."17
In a sense, the Division's adjudicatory proceedings are conducted similar to traditional court proceedings. Parties to the proceeding have the right to present evidence, cross-examine, make objections, bring motions and make oral arguments.18 Rules of evidence are relaxed, but rules of privilege must be strictly adhered to.19 However, discovery is extremely limited. For its part, the Enforcement Section typically produces no more than a pre-trial memorandum summarizing its administrative complaint, and the Division's rules do not expressly grant respondents the right to take depositions or propound interrogatories or requests for documents.20 Indeed, subpoenas for testimony or documents are available only at the discretion of the Division, which may refuse to issue them.21
If the Secretary determines that a person has violated the Act, he may order violators "to cease and desist from such unlawful act or practice [including the sale of securities] and may take such affirmative action, including the imposition of an administrative fine [up to $25,000 per violation], the issuance of an order for an accounting, disgorgement or rescission or any other such relief as in his judgment may be necessary to carry out the purposes of [the Act]."22 The Secretary may also censure, deny, suspend or revoke the registration of any broker-dealer, investment advisor, agent or representative, or take any other appropriate action. Once a final decision or order is mailed by the Presiding Officer, a party may file a Motion for Reconsideration within 10 days or appeal the Director or Presiding Officer's final decision "with the appropriate court," which is typically the Superior Court.23
The March 27 actions resulted in consent orders and did not go through the full adjudicatory process outlined above. However, four out of five of the matters disposed of on March 27 included orders to cease and desist from selling unregistered or non-exempt securities in Massachusetts, a censure and, where applicable, rescission, among other relief.
Increased regulatory scrutiny of ICOs, including active enforcement by the Division, poses practical considerations for those contemplating any token sale that may, even ostensibly, be open to Massachusetts residents. As with the SEC, the Secretary's ability to police this space, however, is predicated upon his ability to assert that the tokens at issue are securities, which is dependent on the fact and circumstances of each case.
Whether or not token sales can be regulated as securities, one thing is clear: the Division has positioned itself at the forefront of the discussion. Those selling from Massachusetts or into Massachusetts should take notice.