No small-fry ICOs spared: SEC sues Opporty, says bounty program was an investment of money

If court filings are any indication, the SEC seems to be just as likely to go after a couple hundred thousand dollar token sale as a billion-dollar ones. 

Thus, in the midst of its well-publicized tangling with Telegram and Kik, in the past week we saw a new lawsuit filed by the SEC in connection with a $600,000 2017 token sale involving a project called "Opporty." (Short for Opportunity or just a bunch of letters strung together?  We will probably never know).

The lawsuit was filed in federal court in the Eastern District of New York, which is located in Brooklyn. As a reminder, the SEC can bring actions against alleged securities law violators in two places – either in a U.S. federal district court or in the SEC’s own administrative tribunals.  Here, they chose the former path. (A judicial proceeding can have more immediate teeth – immediate injunctive relief and asset freezes are all on the table out of the box and an executive branch administrative law judge doesn’t have that power. On the other hand, a federal judge is part of a separate branch of the government unlike an SEC administrative law judge, and maybe – maybe – more open to novel legal arguments).

Three defendants are named in the lawsuit. They are Sergey Grybniak, Opporty International, Inc. and Clever Solutions, Inc. (“Clever”). Clever is named as what’s known as a “relief defendant” which is – oversimplifying a little bit – a defendant who didn’t necessarily do anything wrong but has property that they’re not legally entitled to hold or own.

So, the SEC says that Grybniak created Opporty and was essentially its alter ego. He/it sold OPP tokens to roughly 200 investors and got $600,000 from them in exchange. The tokens were based on Ethereum's ERC-20 standard. The OPP tokens were allegedly unregistered securities and the SEC says that the defendant(s) made material misrepresentations and engaged in other deceptive conduct in connection with the sale.

Defendants allegedly promoted and marketed Opporty's ICO of OPP Tokens and raised the $604,000 in offering proceeds try making material misrepresentations and omissions to investors and engaging in other deceptive conduct during the offering. Defendants did so in order to create materially false and misleading impressions about the legitimacy, use, growth, and success of Opporty's platform, including the materially false and misleading impression that Defendants' efforts to develop Opporty's platform and promote it to small businesses were resulting in the substantial growth of Opporty's user and customer bases, the creation of real content on the platform, and the participation of at least one prominent partner in Opporty's ICO and business.

The Opporty “ecosystem” was touted as a place where “small businesses could list their services and products, use blockchain smart contracts to enter into agreements with customers, and transact business using OPP Tokens.” Like many other ICOs of that time and genre, tokens were sold using so-called Simple Agreements for Future Tokens (“SAFTs”), which were themselves touted by some (and misunderstood by many) as being an inoculation against the SEC and securities laws.

As we see, not so much.

To wit: the SEC says that the tokens were securities and that the issuer(s) made many false statements to potential investors, including that thousands of “verified providers” had signed up to the platform, that 17 million businesses in a catalog were “eligible to conduct business on [the] platform”, that content been created on and for the platform when it hadn’t been, that a major software company was a partner (it wasn’t), and that the OPP tokens were SEC-registered (nope) and it was an SEC-compliant ICO (double nope). 

The Complaint contains a fairly long and honestly kind of predictable recitation about the SAFT and all of the alleged missteps in its issuance. One of the things that these folks allegedly did wrong was that they did apparently do some minimal KYC, they only verified accredited investor status of 6 of 194 investors.  It seems kind of likely (and predictable) that this was the case for dozens if not hundreds of other projects. 

One of the things that did jump out from this otherwise prolix complaint is an allegation that a bounty program that the project used also constituted an offer securities. In short, sweat equity used to market and promote the ICO appears (in the SEC’s eyes) to constitute an investment of money under the three-part Howey investment contract framework.

Additionally, Opporty's bounty program also constituted an offer of securities, because Defendants — in exchange for offering OPP Tokens to bounty program participants — obtained value in the form of the bounty program participants' marketing and promotion of the ICO on social media, websites, and other online forums that substantially increased the offering's exposure worldwide.

This notion that time can satisfy the “investment of money” prong isn’t really ground-breaking from a legal standpoint. Relatedly, the SEC has already pointed that using an “air drop” of tokens doesn’t necessarily immunize you from securities laws. There’s also an SEC administrative order where the same thing was alleged, in the Tomahawk token case. This is an example of the SEC applying the principle (in a federal court lawsuit) that a person’s time/sweat can be enough of an investment to turn something into a security, without money ever changing hands.

You might ask: “But Steve, how can ‘an investment of time’ possibly mean the same thing as ‘an investment of money’? Howey refers to money, and that’s a different thing, right?”

Without answering that question here, given the fact that this is a court – not an administrative proceeding or a consent agreement – it’s certainly possible that we will see the issue litigated.

Another interesting part of this complaint is that it seems like lawyers must have been involved at one point or another. It’s true that the SAFT forms were and are available online and that some people are and have been known to just fill in the blanks on templates. Here, though, there’s also reference to a private placement memorandum, which sounds like something a law firm probably put together. And it also appears that some attempt to was made to verify accredited investor status of US persons and to do KYC on everyone else.

I don’t have SEC telepathy and have no inside information about this case (which is, of course, why I can write about it). If I had to diagnose why the SEC went after these folks, there are a couple of factors that jump out. 

It doesn’t hurt that the guy who set the whole thing up is in Brooklyn, which makes this easy. Also, it was a big mistake to say that the SEC had approved the project. And while the guy apparently filed a Form D with the SEC, he didn’t take all of the steps necessary to confirm accredited investor status. 

Finally, there was the issue of all sorts of misrepresentations that the SEC alleges were made.

***

Not exactly as a post-script to this, but on the subject of people relying on legal advice: as I was poking around some old-ish crypto caselaw this week, I stumbled on a recent bar opinion that involved a lawyer who was involved in E-Gold, a digital currency that preceded bitcoin. The case is In Re Downey, 162 A.3d 162 (D.C. Ct. App. 2017).   

The upshot of the case is this: Downey, a lawyer, way back in the mid-90s got involved with E-Gold as an investor and an officer and director.  He asked for legal advice from a big law firm in 2003 about whether or not E-Gold had to comply with a D.C.’s money transmission licensure requirements or those of the BSA, as amended by the 2001 Patriot Act.  He received somewhat equivocal advice that the company “may wish to consider" whether to register GSR with federal and state authorities.

It warned that GSR's operations "may lead it to be categorized as" an entity that would be "vulnerable to a regulatory claim that it is an unregistered money service business." However, the memorandum also stated that "there is no clear answer" to whether E-Gold qualified as a "financial institution" covered by the Patriot Act, and "there is no definition that completely captures E-Gold's business.”

Anyway, long story short, E-Gold didn’t register. This was not a good thing. Downey was convicted of violating the Bank Secrecy Act and narrowly missed spending time in prison. The statute is a strict liability one and intention doesn’t matter, the Court pointed out. He was also subject to bar discipline. 

You see, if you’re convicted of a crime, you can lose your license. Bar counsel argued stridently that he should be disbarred (I’m glossing over some details that aren’t really relevant here) and the Court ultimately said that an informal admonition was enough because he had tried to get legal advice and wasn’t intentionally violating the law or doing something related to his law practice.

In conclusion: hoo boy. The fact that tech is new and the law is “uncertain” is also apparently no inoculation from the BSA or other laws, which is also sort of one of the things you can take away from the OPP lawsuit.