August 18, 2022

SEC Charges Crypto Company with Section 5 Violations

On the heels of an insider trading action and reported investigation into Coinbase, the SEC is sending another strong signal that it intends to regulate digital assets (one way or another). Earlier this week, the agency announced charges against a group of entities and their founder for their roles in unregistered crypto offerings. Here are some of the allegations from the 17-page complaint:

1. From at least 2017 through the present, Dragonchain conducted an unregistered offering of a crypto asset called a “Dragon” (“DRGN”), illegally raising over $16 million in proceeds through unregistered offers and sales of these securities to approximately 5,000 investors in the United States and abroad. Dragonchain used these proceeds to try to develop a type of blockchain technology – a peer-to-peer database spread across a network of computers – that businesses can incorporate into their daily activities. Dragonchain offered and sold DRGN tokens through channels that included a Dragonchain website, social media, conference appearances, and Telegram.

2. In 2017, Dragonchain minted DRGNs and conducted an offering of 55% of them in two phases: (1) a discounted “presale” in August 2017 to members of a crypto investment club, and (2) an initial coin offering (“ICO”) in October and November 2017 marketed predominately to crypto investors. Through this offering, Dragonchain raised approximately $14 million.

5. Dragonchain’s marketing materials explicitly stated that the value of the token would increase as adoption of its technology grew. Dragonchain told purchasers that the value of DRGNs would rise as the Dragonchain “ecosystem” matured. Dragonchain also stated that it would use proceeds of the offering to develop additional features and market its technology to businesses, thereby promoting adoption of its technology.

6. Dragonchain also made clear to investors that DRGNs would be “listed” on trading platforms. Roets, Dragonchain’s founder, personally told investors that he understood that liquidity and the ability to exit an investment quickly was an advantage of being a crypto investor over a traditional investor.

7. Dragonchain retained social media forum moderators and crypto influencers who regularly discussed DRGNs’ investment value, trading prices, and market capitalization, and Dragonchain’s Twitter profile regularly reposted others’ investment value-related tweets about DRGNs.

11. The Dragon Company, meanwhile, used DRGNs to pay service providers for a variety of services provided to Dragonchain during 2019 through 2022, thereby selling DRGNs through an illegal unregistered offering.

After painting that picture, the SEC refers back to its 2017 Section 21(a) Report, which was issued before Dragonchain’s offering and found that the crypto assets at issue there were “investment contracts” – and therefore, securities. The complaint then continues with another 7+ paragraphs of facts that the SEC believes show a violation of Sections 5(a) and 5(c) of the Securities Act. The SEC is seeking permanent injunctions, disgorgement, and civil money penalties.

The company had been notified in advance of this investigation – and sent an open letter to the SEC in response. With the way things are going, there will probably be more crypto enforcement actions to come.

Liz Dunshee