ENFORCEMENT—Enforcement staff gives update on Division’s digital token activities - 19 October 2021

The SEC will continue to pursue cases of unregistered digital tokens.

Members of the SEC’s Division of Enforcement staff spoke at the Practising Law Institute’s recent SEC Speaks conference on cyber-related issues, including digital token enforcement. The staff discussed how the Division pursues digital token-related cases as well as SEC victories in federal court over offerings made by Kik and Telegram.

Cyber unit update. Kristina K. Littman, chief of the Division’s Cyber Unit, described recent actions taken by the Division and the two approaches used by the staff. One approach involves actions against entities offering digital tokens that meet the definition of a security but do not register the tokens as such or otherwise qualify for an exemption. In these types of cases, the entity may want to continue as a going concern and is given the opportunity to either register the tokens as securities or return money to harmed investors. A recent example of this type of enforcement action is the SEC’s lawsuit against Blockchain of Things, which had raised nearly $13 million in its digital token offering. As part of the settlement with the SEC, Blockchain of Things agreed to pay a $250,000 civil penalty. The company also agreed to return funds to investors and to register its tokens with the SEC, including making the requisite filings for securities.

The second approach outlined by Littman involves companies that do not wish to travel that route, in which case the Division’s approach is to get as much money back to investors as quickly as possible. A settlement in this scenario is likely to include a significant penalty, the establishment of a fair fund, and some sort of undertakings or conduct-based injunction aimed at preventing further harm to investors and the market. Littman cited Commission actions against Loci, Inc., Unikrn, Inc., and Boon.Tech. In addition to disgorgement, these companies were ordered to pay $7.6 million, $6.1 million, and $150,000 respectively.

In addition to the Commission’s enforcement actions against companies offering unregistered digital tokens, the Division will continue to pursue illegal “touting” activities, Littman said. Celebrities are frequent “touters” of unregistered ICOs and receive compensation for their touting services.

While many of these touting cases have involved high-profile celebrity touters, others involve a paid-for platform to promote ICOs. An example of this type of enforcement action is the SEC’s case against Coinschedule. Visitors to were presented with information about digital tokens called “listing” profiles, which also included links to the token issuers’ own websites and a “trust score” that Coinschedule claimed reflected its evaluation of the “credibility” and “operational risk” for each digital token offering based on a “proprietary algorithm.” However, the token issuers actually paid Coinschedule to profile their token offerings on, which it failed to disclose.

Telegram and Kik—victories for Howey test. Many of the SEC’s cases against companies offering unregistered digital tokens stem from the 1946 Supreme Court decision SEC v. W. J. Howey Co. The Howey case outlines a test for determining what is an investment contract, and therefore a security, under federal law. Chief Litigation Counsel Bridget Fitzpatrick described how Howey is still relevant in determining whether a particular offering is a security in two recent cases involving digital tokens from Telegram and Kik. According to Fitzpatrick, both companies offered a similar defense as to why the digital tokens were not registered: “What? The law applies to me? How was I to know?” Fitzpatrick said both companies supposedly wanted the SEC to be more clear that the law actually applied to them.

Fitzpatrick said the court soundly rejected the defense by both companies that the Supreme Court’s decision was unconstitutionally vague as it applied to cryptocurrency. Judge Castel’s wrote a 44-page opinion in the Telegram case (a preliminary injunction opinion). In Kik, which was a summary judgment opinion in favor of the SEC, Fitzpatrick noted that the company actually went to the SEC’s regulatory counterpart in Canada. Kik was told by the Canadian regulators in response to Kik’s arguments that its tokens were securities that Canada also applies the Howey test, and told the company that it was pretty sure the tokens were securities under Canadian law and probably also in the U.S. Instead of going to SEC to figure it out, Kik went ahead and made the offering. The Southern District of New York agreed with the SEC that Kik’s tokens were indeed securities under Howey. Right now, Kik opinion is the seminal opinion on Howey arguments, Fitzpatrick said.

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