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SEC proposes new protections for crypto assets
On February 15, the SEC proposed new rules to enhance protections for customer assets, including cryptocurrency assets, managed by registered investment advisers. (See also SEC Fact Sheet here.) The proposed rules would implement measures under the Investment Advisers Act of 1940 to address how client assets are safeguarded, and would broaden the definition of “asset class” to ensure investment advisers are protecting not only their clients’ securities and funds but also “other positions held in a client’s account,” including crypto assets.
Under the proposed rules, investment advisers would be required to, among other things, segregate such crypto assets into separate accounts for safekeeping, prevent commingling of assets with the adviser’s or another related persons’ assets, and place crypto assets with a qualified custodian such as a federal or state-chartered bank or savings association, a registered broker-dealer or futures commission merchant, or certain foreign financial institutions. Foreign financial institutions would have to adhere to enhanced requirements to serve as a qualified custodian.
In a statement accompanying the release of the proposed rules, SEC Chairman Gary Gensler stated that “advisers who trade an investor’s assets cannot circumvent the custody rule and the safeguards it provides.” Gensler added that the proposal would impose several recordkeeping requirements, and require, for the first time, that advisers and qualified custodians enter into written agreements to help guarantee that customer assets are being protected.
Comments on the proposed rules are due 60 days after publication in the Federal Register.
SEC awards whistleblowers $28 million
On January 24, the SEC announced awards totaling nearly $28 million to joint whistleblowers whose information and assistance led to successful SEC enforcement actions. According to the redacted order, the joint whistleblowers’ provided information that prompted the opening of the SEC staff’s investigation and significantly contributed to the success of the action through substantial analysis and ongoing assistance. The SEC also noted that the joint whistleblowers’ actions helped result in the return of millions of dollars to harmed investors.
SEC commissioner discusses state of the crypto industry
On January 20, SEC Commissioner Hester M. Peirce spoke before the Digital Assets at Duke Conference discussing cryptocurrency lessons for the future. In her remarks, Peirce discussed the current state of cryptocurrency, stating that “the crypto world is burning.” She encouraged the audience to “not wait for regulators to fix the problems that bubbled to the surface in 2022” within the crypto industry, and instead incentivize good behavior. She also emphasized “the point of crypto,” which she considers “is not driving up crypto prices so that you can dump your tokens on someone else. Digital assets need to trade, so centralized venues or decentralized exchange protocols are necessary, but trading markets are not the ultimate point.” Among other things related to crypto, she said lessons from traditional finance are equally applicable in crypto. For example, she noted that “[h]igher returns come with higher risks.” She also suggested that the SEC should conduct some form of notice and comment process to resolve the thorniest crypto-related policy issues.
Peirce noted that “sandboxing is coming.” She then explained that SEC Chair Gary Gensler has requested “‘staff to sort through how we might best allow investors to trade crypto security tokens versus or alongside crypto non-security tokens,’[] which is an area in which experimentation through no-action letters and exemptions would be possible.” She also strongly agrees with his sentiment that “‘[g]iven the nature of crypto investments . . . it may be appropriate to be flexible in applying existing disclosure requirements.’”
She also expressed that “[r]egulation is not a silver bullet, but understanding whether, by whom, and how the company is regulated can help you calibrate your own due diligence.” Peirce said that the SEC “needs to conduct better, more precise, and more transparent legal analysis” in crypto. She noted that its continued use of the precedent from the 1946 U.S. Supreme Court case in SEC v. W.J. Howey Co. has “fleshed out the investment contract subcategory of securities, we repeat the mantra that all, or virtually all, tokens are securities,” calling the SEC’s application of the test to crypto tokens “askew.” She then noted that “an initial fundraising transaction involving a crypto token can create an investment contract, but the token itself is not necessarily the security even if it is sold on the secondary market.” Peirce also noted that the SEC often “refers to the crypto assets themselves as securities.”
Company to pay $45 million to SEC, states for unregistered crypto-lending product
On January 19, the SEC charged a Cayman Islands digital asset firm for allegedly failing to register the offer and sale of its retail crypto-asset lending product. According to the SEC’s cease-and-desist order, the company’s product allowed U.S. investors to tender certain crypto assets with the company, which were then deposited in interest-yielding accounts and used by the company to generate income and fund interest payments to investors.
The SEC maintained that the company’s product was marketed as an opportunity for investors to earn interest on their crypto assets, and that company actions “included staking, lending, and engaging in arbitrage on purportedly ‘decentralized’ finance platforms; investing in certain crypto assets; loaning funds to retail and institutional borrowers; and entering into options and swap contracts with respect to the crypto assets tendered”— resulting in the company acquiring $2.7 billion in assets from approximately 112,000 investors. The SEC found that because the product qualified as a security and did not qualify for an exemption from registration under the Securities Act of 1933, the company was required to register its offer and sale of the product, which it failed to do.
The company did not admit or deny the SEC’s findings, but agreed to pay $22.5 million to the SEC, and said it would stop offering and selling the unregistered lending product to U.S. investors. The SEC considered remedial actions promptly taken by the company, as well as its cooperation with Commission staff in determining the settlement amount. The SEC reported that the company voluntarily stopped offering its product to new U.S. investors and ceased paying interest on new funds added to existing accounts after the SEC announced charges against a different company that offered a similar crypto investment product. The company also announced that the product would stop being offered in certain states and that it was phasing out all of its products and services in the U.S.
The company also agreed to pay another $22.5 million to state regulators from California, Kentucky, Maryland, New York, Oklahoma, South Carolina, Vermont, and Washington in a parallel action claiming the company offered interest-earning accounts without first registering the investment products as securities. According to the announcement, the company allegedly failed to comply with state securities registration requirements, and, among other things, deprived investors “of critical information and disclosures necessary to understand the potential risks of the [product].”
SEC awards whistleblowers approximately $18 million
On January 19, the SEC announced three whistleblower awards totaling approximately $18 million to claimants who provided information and assistance that led to a successful enforcement action. According to the redacted order, the first whistleblower voluntarily provided detailed and significant information that prompted the opening of an investigation into a fraudulent scheme and had a significant impact on the overall success of the enforcement action. The whistleblower’s assistance saved staff time and resources, the SEC said, adding that the second and third whistleblowers voluntarily provided timely information later in the investigation that also significantly contributed to the enforcement action’s success.
SEC issues $5 million whistleblower award
On January 13, the SEC announced an award totaling nearly $5 million to a whistleblower whose new information and assistance led to a successful SEC enforcement action. According to the redacted order, the whistleblower provided substantial ongoing information that helped SEC staff shape its investigative strategy, identify witnesses, and draft document and information requests, which saved staff time and resources during the investigation.
SEC charges companies for offering and selling unregistered crypto asset securities
On January 12, the SEC filed a complaint in the U.S. District Court for the Southern District of New York against two companies (collectively, defendants), alleging that they were involved in the unregistered offer and sale of securities through a crypto asset lending program. According to the complaint, in December 2020, one defendant entered into an agreement with the other defendant to offer customers, including retail investors in the U.S., an opportunity to loan their crypto assets to the defendant in exchange for its “promise to pay interest on those investors’ crypto assets.” The complaint further alleged that in February 2021, the defendants began offering the program to retail investors, which included that there was no minimum investment amount to be eligible to participate, and that investors tendered their crypto assets to one of the defendants acting as the agent to facilitate the transaction. The SEC noted that the defendant deducted an agent fee, sometimes as high as 4.29 percent. The complaint also alleged that the defendant then exercised its discretion in how to use investors’ crypto assets to generate revenue and pay interest to investors. In November 2022, the company announced that it would not allow its investors to withdraw their crypto assets because the company did not have sufficient liquid assets to meet withdrawal requests following volatility in the crypto asset market. These activities violated Section 5(a) and 5(c) of the Securities Act the SEC said. The SEC’s complaint seeks permanent injunctive relief, disgorgement of ill-gotten gains, prejudgment interest, and civil penalties.
SEC brings charges in connection with alleged $45 million crypto fraud
On January 4, the SEC filed a complaint in the U.S. District Court for the Eastern District of Michigan against a cryptocurrency operation and connected individuals and entities (collectively, defendants), alleging that they were involved in a fraudulent scheme that generated more than $45 million. According to the complaint, the defendants falsely claimed that investors could generate extravagant returns by investing in a blockchain technology that would be sold for trillions of dollars. More specifically, from at least 2019 to 2022, the defendants allegedly disseminated false and misleading statements to investors regarding the purported value of the blockchain technology, the parties involved in the supposed sale of the blockchain technology, and the use of investment proceeds. The complaint further alleges that the defendants collectively misappropriated millions of dollars of investor funds for personal use. These activities violated the antifraud and registration provisions of the Securities Act and Exchange Act and other requirements, according to the SEC. The SEC’s complaint seeks disgorgement plus pre-judgment interest, penalties, and permanent injunctions against all defendants, and officer and director bars against the individuals, in addition to a conduct-based injunction against one of the individuals.
DFPI orders online platform to cease offering crypto-related products
On December 21, the California Department of Financial Protection and Innovation (DFPI) announced it has ordered an online platform offering several crypto-related services and products to desist and refrain from violating the California Securities Law and the California Consumer Financial Protection Law. According to DFPI, the company, which is registered with the California Secretary of State, offers services including (i) a peer-to-peer loan brokering service in which it claims that loans are secured by borrowers’ crypto assets; (ii) an interest-bearing crypto asset account that promises a fixed annual percentage rate yield; and (iii) an interest-bearing fiat account that promises a fixed annual percentage interest rate return. DFPI maintained that the company engaged in unlicensed loan brokering by offering and providing brokering services for personal loans made from one consumer to another (known as peer-to-peer lending), and conducted the unregistered sale of securities, in which consumers’ assets were pooled together with the stated purpose of generating passive returns. DFPI claimed that the company was and is not registered to offer investment contracts or to operate in this capacity with any relevant authority. Finding that these peer-to-peer lending services and interest-bearing accounts violate state law, including a prohibition against engaging in unlawful acts or practices, DFPI ordered the company to stop offering the services and products in California.
CFTC orders respondent to pay $6.5 million for CEA violations
On December 20, the CFTC announced a settlement with a registered futures commission merchant (respondent) for allegedly violating the Commodity Exchange Act, Commission regulations, and Bank Secrecy Act compliance requirements. According to the CFTC, the respondent allegedly “failed to implement an adequate anti-money laundering [] program, particularly as applied to a futures and options trading account controlled by [a customer],” and “failed to implement risk-based limits concerning trading by [a customer].” The CFTC also alleged supervisory and recordkeeping failures stemming from the inadequate anti-money laundering program. The respondent is ordered to pay a $6.5 million civil money penalty and undertake certain remedial measures relating to the violations.