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Several recent “first of kind” enforcement proceedings continue the flurry of enforcement activity by regulators. In two settled proceedings, the Securities and Exchange Commission (SEC) brought two cases for failure to register digital tokens as securities in connection with initial coin offerings (ICOs), without allegations of fraud. With such enforcement actions now commonplace, a “crypto winter” has clearly set in. In another development, a federal court recently issued the first opinion concluding that the SEC had failed to establish that a digital asset issued in connection with an ICO was a “security” under the federal securities laws, underscoring that digital assets will not be subject to a one-size-fits-all analysis.
As for the two settled charges, according to the SEC’s orders, Paragon Coin, Inc. and AirFox launched their ICOs in 2017. Paragon is an online company that was established to implement blockchain technology in the cannabis industry, as well as to work towards legalization of cannabis. Through its ICO, Paragon raised approximately $12 million in digital assets to develop and expand its business. As for AirFox, it sells mobile technology intended to allow customers to earn free or discounted data by watching advertisements on their phones. AirFox raised approximately $15 million in its ICO to help expand its business overseas. Neither Paragon nor AirFox registered their ICOs.
In charging the two companies with registration violations, the SEC’s legal analysis in both cases was very similar (in some places identical). As an initial matter, the orders pointed out that the ICOs occurred after the SEC issued the DAO Report, which said that digital assets may qualify as “securities” under the securities law, and thus may require registration. The clear message from the SEC is that the companies should have been on notice. Moreover, applying the Supreme Court’s Howey test, the SEC determined that the digital tokens at issue were securities because (1) the tokens were offered in general solicitations to US investors, (2) purchasers had a reasonable expectation of profits from their investment, (3) the investors’ profits would be driven by the managerial efforts of others (i.e., Paragon and AirFox), and (4) investors’ expectations were primed by Paragon and AirFox through marketing and promotional materials that touted the ICOs.
To settle the charges, Paragon and Airfox each agreed to pay a $250,000 civil money penalty, register their tokens as securities with the SEC, and reimburse investors who purchased tokens in the offerings.
These two cases are important for a variety of reasons. For one thing, unlike many previous crypto-enforcements, they did not involve any allegations of fraud or misrepresentation. Instead, they were pure failure-to-register cases. Moreover, for companies that have not yet launched an ICO, the SEC’s press release warned that “[t]hese cases tell those who are considering taking similar actions that [the SEC] continue[s] to be on the lookout for violations of the federal securities laws with respect to digital assets.” In other words, future ICO issuers should carefully consider whether their tokens are “securities” under the Howey factors and, if so, make sure they are complying with all the attendant securities laws, including registration requirements. Finally, although we expect the SEC to bring similar actions in the near future against issuers who have already raised capital through ICOs, the SEC’s press release explains that these cases contain a forward-looking compliance roadmap of sorts: “By providing investors who purchased securities in these ICOs with the opportunity to be reimbursed and having the issuers register their tokens with the SEC, these orders provide a model for companies that have issued tokens in ICOs and seek to comply with the federal securities laws.” Thus, issuers should consider taking proactive steps—including registering their tokens and reimbursing their investors—to minimize the likelihood or extent of an enforcement proceeding.
Although the SEC obtained favorable settlements against Paragon and AirFox, the SEC recently suffered a setback in its case against a company called Blockvest. According to the SEC, Blockvest materially misled investors by falsely claiming that its ICO had been registered with a “fictitious regulatory agency” similar to the SEC to “create legitimacy and an impression that [its] investment is safe.” After the SEC filed a federal complaint and a motion for preliminary injunction, the court considered whether the digital asset at issue was a security under the Howey test. The Southern District of California ultimately denied the SEC’s motion for a preliminary injunction because there were “disputed issues of fact” as to what the “investors relied on, in terms of promotional materials, information, economic inducements or oral representations . . . before they purchased” the tokens.
Although the Blockvest ruling shows that courts will not rubberstamp SEC arguments in the cryptocurrency context, the value of this opinion is limited because the court did not reject the SEC’s arguments on the merits; rather, it held that the case should proceed to full discovery in light of the material facts in dispute. And, just two months earlier, in September 2018 Judge Raymond Dearie of the Eastern District of New York denied a motion to dismiss the criminal prosecution of Maksim Zaslavskiy, who was charged with allegedly defrauding investors by falsely representing that two cryptocurrencies (REcoin and Diamond) were backed by real estate and diamonds, respectively. Judge Dearie ruled that the prosecution of Zaslavskiy could continue.
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In all, at this time last year, the value of Bitcoin was seeing record highs of nearly $20,000 while enforcement activity remained relatively low and courts had not yet seriously begun to grapple with how to categorize digital assets. In the ensuing months, numerous regulators have gotten into the act, with SEC and others bringing enforcement actions to halt fraudulent schemes, and more recently, to push back on projects that failed to register with the SEC. Courts have also begun to put contours around the Howey analysis. With all those developments, the price of Bitcoin is hovering in the $4,000 range, leading commentators to claim a crypto winter. As we head into 2019, time will tell whether the increased clarity from enforcement authorities resulting from a year of enforcement activity will lead to a springtime thaw.
 U.S. Securities and Exchange Comm’n, In the Matter of Paragon Coin, Inc., Order Instituting Cease-and-Desits Proceedings Pursuant to Section 8A of the Securities Act of 1933, Making Findings, and Imposing Penalties and a Cease-and-Desist Order, Release No. 10574, Nov. 16, 2018, https://www.sec.gov/litigation/admin/2018/33-10574.pdf.
 U.S. Securities and Exchange Comm’n, In the Matter of CarrierEQ, Inc., d/b/a/ Airfox, Order Insituting Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933, Making Findings, and Imposing Penalties and a Cease-and-Desist Order, Release No. 10575, Nov. 16, 2018, https://www.sec.gov/litigation/admin/2018/33-10575.pdf.
 U.S. Securities and Exchange Comm’n, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Release No. 81207, July 25, 2017, https://www.sec.gov/litigation/investreport/34-81207.pdf.
 U.S. Securities and Exchange Comm’n, Press Release, “Two ICO Issuers Settle SEC Registration Charges, Agree to Register Tokens as Securities,” https://www.sec.gov/news/press-release/2018-264.
 Securities and Exchange Comm’n v. Blockvest, LLC and Reginald Buddy Ringgold, III a/k/a Rasool Abdul Rahim El, Case No.: 18CV2287-GPB(BLM), Order Denying Plaintiff’s Motion for Preliminary Injunction (S.D. Cal. Nov. 27, 2018).
 U.S. v. Zaslavskiy, Memorandum & Order, 1:17-cr-00647 (E.D.N.Y. Sept. 11, 2018).