December 6, 2017

ICOs: SEC Enforcement’s New “Cyber Unit” Enters the Fray

Whatever their underlying merits, coin offerings have quickly attracted their fair share of fraudsters – and the bad guys’ propensity for ICO scams hasn’t been lost on the SEC.  In an October speech, Enforcement Co-Director Stephanie Avakian said that concerns about abuses in this area were one of the factors that led the SEC to create a new “Cyber Unit” in the Division of Enforcement:

As folks likely know, the Commission recently issued a Report of Investigation cautioning that offers and sales of digital assets by “virtual” organizations – often referred to as “Initial Coin Offerings” or “Token Sales” – are subject to the requirements of the federal securities laws, which can include the registration of securities offerings.

Blockchain technology presents many interesting issues and can of course present legitimate opportunities for raising capital. But, like many legitimate ways of raising capital, the popular appeal of virtual currency and blockchain technology can be an attractive vehicle for fraudulent conduct. We think that creating a permanent structure for the consideration of these issues within the Cyber Unit will ensure continued focus on protecting both investors and market integrity in this space.

Earlier this week, the Cyber Unit made its first big splash with the announcement that it had obtained an emergency asset freeze to stop what it called “a fast moving fast-moving Initial Coin Offering (ICO) fraud that raised up to $15 million from thousands of investors since August by falsely promising a 13-fold profit in less than a month.”

The alleged scam involves a recidivist securities law violator and his company, and the SEC’s complaint alleges that the defendants marketed and sold securities called “PlexCoin” – claiming that investments in PlexCoin would yield a 1,354% profit in less than 29 days.

The announcement notes that this represents the first action filed by SEC’s new Cyber Unit – and the extent of the ICO fraud problem strongly suggests that it won’t be the last. We’re posting memos in our “ICOs” Practice Area.

ICOs:  Offerings Continue to Boom – But Class Actions Start to Bloom

The potential fraud issues associated with coin offerings haven’t just attracted the attention of the SEC.  While these offerings continue to attract a high-level of investor interest, this “D&O Diary” blog points out that they’re also becoming an attractive target for securities class actions.  Here’s the intro:

According to the latest update on the CoinSchedule website, there have been a total of 228 initial coin offerings so far this year through mid-October, raising a total of over $3.6 billion. At least five of this year’s ICOs have raised over $100 million. This burgeoning activity notwithstanding, ICOs are at the center of controversy.

Among other things, China and South Korea have banned ICOs. The SEC has already shown its willingness to pursue enforcement actions against ICO sponsors, as discussed further here. And now a high-profile statement by one of the country’s leading securities regulation experts suggests even greater scrutiny may lie ahead. In the meantime, as discussed below, ICO and cryptocurrency-related litigation appears to be proliferating.

The blog goes on to provide details on several recent class action lawsuits involving coin offerings.

Whistleblowers: Supreme Court Hears Argument on Internal Whistleblower Issue

Last week, the Supreme Court heard oral arguments in Somers v. Digital Realty Trust – which gives the Court an opportunity to resolve a split between the circuits concerning whether Dodd-Frank’s whistleblower protections extend to individuals who report wrongdoing internally, but don’t reach out to the SEC. This recent blog from Cydney Posner reviews the case and the issue before the court. Here’s an excerpt:

In this case, the 9th Circuit had refused to dismiss Somers’ whistleblower claim brought under Dodd-Frank’s anti-retaliation provision, even though he had failed to report the violation to the SEC. As you may recall, Dodd-Frank added Section 21F to the Exchange Act, establishing new incentives and protections for whistleblowers, including monetary awards for reporting information, confidentiality provisions and employment retaliation protections.

The statute defines “whistleblower” as a person who reports potential violations of the securities laws to the SEC; however, in promulgating rules under the statute, the SEC distinguished the whistleblower anti-retaliation provisions from the award provisions, applying a broader definition in the context of anti-retaliation that would not require reporting to the SEC.

The 2nd Circuit agrees with the 9th Circuit’s approach – but the 5th Circuit has held that in order to qualify for protection, a whistleblower must report the wrongdoing to the SEC.

John Jenkins