On December 1, 2017, the SEC’s Cyber Unit filed charges against PlexCorps and related parties in an emergency action to prevent the further misappropriation of investor funds raised through a fraudulent initial coin offering (“ICO”).1 The charges are the first brought by the SEC’s Cyber Unit, which was created in September 2017 to target cyber-related misconduct, including violations involving distributed ledger technology and ICOs.
The SEC’s complaint alleges that the defendants – a “recidivist securities law violator,” his partner and his unincorporated organization, PlexCorps – illegally raised approximately $15 million from tens of thousands of investors by marketing and selling securities called “PlexCoin” (or “PlexCoin Tokens”) by promising, among other things, investor returns of 1,354% profit in under 29 days.
The complaint alleges violations of the registration requirements under the Securities Act of 1933 (the “Securities Act”) and the anti-fraud provisions of both the Securities Act and the Securities Exchange Act of 1934 (the “Exchange Act”).2
Registration Violations
The SEC’s complaint alleges that the PlexCoin ICO was an illegal offering of securities because no registration statement had been filed or was in effect in connection with the offer and sale of PlexCoin Tokens, and no applicable exemption from registration was available. The SEC’s determination that the PlexCoin Tokens are securities is consistent with the analysis in its July 2017 Report of Investigation under Section 21(a) of the Securities Exchange Act of 1934 (the “DAO Report”), which described the SEC’s investigation of another unincorporated organization’s ICO.3 In the DAO Report, the SEC stated that the foundational principles of the federal securities laws apply to ICOs, and concluded that certain coins or tokens offered through ICOs meet the definition of investment contract.4
The SEC has brought other enforcement actions based on the position that those who offer and sell securities are required to comply with the registration requirements of the federal securities laws, regardless of whether the securities are purchased with cryptocurrencies or distributed with blockchain technology.5
Anti-Fraud Violations
The SEC’s complaint also alleges that the PlexCoin ICO violated applicable federal anti-fraud provisions because the defendants made materially false and misleading statements in connection with the offer and sale of PlexCoin Tokens, including by comparing the supposed returns on PlexCoin to those in other ICOs (which had supposed returns as high as 88,000%); claiming that the PlexCorps team consisted of experts stationed internationally; and claiming that the identity of PlexCorps’ executives had to remain hidden to protect PlexCorps’ security and avoid poaching by competitors.
Although the SEC has issued warnings to investors about companies claiming to be involved with ICOs,6 the SEC has yet to bring an anti-fraud enforcement action in connection with the offering and sale of securities through an ICO. The complaint against PlexCorps, along with the Cyber Unit’s stated focus on violations concerning distributed ledger technology and ICOs, suggests that anti-fraud enforcement actions involving operators of cryptocurrency investments may be forthcoming.
Notably, the Commodity Futures Trading Commission, which has asserted authority over virtual currencies (including cryptocurrencies) after determining that virtual currencies are commodities, has also demonstrated its authority to enforce the anti-fraud provisions of the Commodities Exchange Act against operators of deceptive schemes involving cryptocurrency investments.7
Conclusion
The SEC’s complaint reflects the SEC’s commitment to applying the existing securities law framework to cryptocurrency investments, and is a reminder for market participants to be mindful of their obligations under the federal securities laws. Since the release of the DAO Report, many issuers of cryptocurrencies and tokens have been focused on complying with, or structuring around, the registration requirements of the Securities Act. However, regulators on both the federal and state levels are also apt to bring actions based on applicable anti-fraud statutes and regulations, and issuers would be well advised not to neglect that aspect in connection with their offerings of cryptocurrencies and tokens. Importantly, while the anti-fraud provisions of the securities laws may not apply to cryptoassets that are not securities, there are other anti-fraud statutes and regulations that apply to offers and sales of such cryptoassets.
Seward & Kissel will continue to monitor any developments regarding regulatory treatment of cryptocurrencies and ICOs. If you have any questions, please contact one of the attorneys listed below or your Seward & Kissel contact attorney.
For previous updates and guidance on cryptocurrencies and ICOs prepared by Seward & Kissel, please refer to the following:
The Hot Money: Cryptocurrencies and Implications for Investment Advisers
CFTC Charges Bitcoin Ponzi Scheme
CFTC Considers Virtual Currency Derivatives to be Commodity Interests
SEC Speaks Out on ICOs, Cautions That Some May Involve Offering of Unregistered Securities
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1 SEC v. PlexCorps et al., No. 17-7007 (E.D.N.Y. Dec. 1, 2017)
2 The defendants were charged with engaging in the unlawful sale and offer to sell securities in violation of Sections 5(a) and 5(c) of the Securities Act, and with committing securities fraud in violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
3 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Securities Act Release No. 81207 (July 25, 2017)
4 An investment contract is a scheme that “involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946). The SEC concluded that the PlexCoin Tokens meet this standard because investors in the PlexCoin ICO were promised returns stemming from: (i) the appreciation in value of the PlexCoin Tokens based on PlexCorps management’s investment of the ICO proceeds; (ii) the appreciation in value of the PlexCoin Tokens based on the efforts of PlexCorps’ marketing team, which included listing the PlexCoin Tokens on a digital asset exchange; and (iii) the distribution to investors of profits from the PlexCorps enterprise.
5 See, e.g., In the Matter of BTC Trading Corp. and Ethan Burnside, Securities Act Release No. 9685 (December 8, 2014), (defendant offered to sell and buy the securities of two virtual currency enterprises that he owned and operated without filing a registration statement with the SEC and with no applicable exemption to the registration requirements); SEC v. Shavers, 2014 U.S. Dist. LEXIS 130781 (E.D. Tex. Sept. 18, 2014) (defendant offered and sold the unregistered securities of an entity defendant used to operate a bitcoin Ponzi scheme); In the Matter of Erik T. Voorhees, Securities Act Release No. 9592 (June 3, 2014), (defendant publicly offered the unregistered securities of two companies in exchange for virtual currency).
6 Investor Bulletin: Initial Coin Offerings, Investor.gov (July 25, 2017); Investor Alert: Public Companies Making ICO-Related Claims, Investor.gov (Aug. 28, 2017)
7 CFTC v. Gelfman et al., No.17-7181 (S.D.N.Y Sept. 21, 2017)