The bitcoin made me do it: this week in crypto, law and disorder

This week’s crypto peregrination involves a trifecta of misconduct. First, a serious sanctions order in the Kleiman v. Wright litigation seems to have led to a negotiated settlement. Second, we look at an enforcement action involving a Florida securities lawyer who should have known better and ponder consequences for utility token lawyers. Third, we’ll take a look at the SEC/FINRA joint statement on digital asset securities and a recent sanctions order against a broker whose botched bitcoin deal ended badly for him.

1. Kleiman v. Wright goes the way of all flesh?

While lawsuit outcomes are difficult to predict, there are a couple of guarantees — every lawsuit will have a beginning, an end, and will cost money. So it’s no great surprise to see that the long-running Kleiman v. Wright case seems to have run out of air and into a settlement, as the joint motion below suggests is imminent:

Joint Motion Kleiman by Anonymous RXEhFb on Scribd

For those of you who weren’t paying any attention to this case, it involved a dispute over several billion dollars in bitcoin between Craig Wright, BitcoinSV front man and the self-proclaimed inventor of bitcoin and one true Satoshi, and Ira Kleiman, the executor of David Kleiman’s estate. Kleiman says that his brother invented Bitcoin with Wright and that Wright took Kleiman’s share of jointly owned early bitcoin, now worth billions of dollars.

After two federal judges called Wright out for being less than truthful, denied a motion to dismiss and entered a devastating sanctions order, settlement was frankly the only good option for Wright, short of a decision on the merits by a judge who has already made it clear that he thinks he’s a liar.

Settlements like this one are typically confidential, so unless it involves movement of bitcoin from early addresses, we may never know anything about the terms.

2. Lawyers, securities fraud and tokens

For a brief period two to three years ago, any lawyer connected even remotely to blockchain would get inbound inquiries from potential clients in the crypto space who wanted help with things like, oh, decentralizing chicken farm equipment delivery in central Europe and selling tokens to American retail investors. One of the funny/not-so-funny features of these calls was that they without fail included a request that the lawyer take their compensation in the tokens they were being asked to design.

I was always dubious of the tokens for token advice concept (and, no, I don’t own any chicken equipment tracking tokens). As a practical matter, it’s lousy business to get paid in an illiquid asset for which there’s no market. More importantly, perhaps, there are some really serious professional ethics issues involved in taking securities like things from clients as compensation. This is even more so if you give advice about a thing that you say isn’t a security and profit from it and it’s actually a security and you should have known better and you profited from your bad advice.

Stated a little bit differently, giving securities law advice about assets you accept as payment creates the risk of jumping from malpractice for being wrong to securities fraud and conspiracy.

A recent non-token sale/crypto case illustrates this. According to the SEC, Jan Atlas, a prominent Florida lawyer, allegedly wrote two opinion letters

in which he knowingly falsified or omitted important facts and offered the opinion that 1 Global’s notes likely were not securities. The complaint alleges that 1 Global [his client] used the opinion letters to falsely represent to a network of external sales agents that its notes were not securities and that its offering did not have to be registered with the SEC. 1 Global then allegedly induced thousands of retail investors to invest hundreds of millions of dollars in its notes. According to the complaint, Atlas received a percentage of the commissions generated on the sale of 1 Global’s notes, which totaled more than $600,000.

He was also criminally indicted. We’ll be going into more detail about the facts of this case in this week’s Crypto Caselaw Minute, but it illustrates the risk lawyers face when they not only give bad securities law advice, but also profit from it. My prediction is that we will see similar enforcement action in the next year or two against a lawyer or lawyers or wrote opinion letters or gave bad advice to token sale issuers and profited from it.

There was briefly — and ill-advisedly — a market for “utility token” opinion letters. Some lawyers were asked to provide them for purposes of getting clients listed on exchanges. That also seemed like a bad idea at the time, and I suspect that some of these chickens will also soon come home to roost.

3. Broker loses licenses over botched bitcoin scheme

Back in July, the SEC and FINRA issued a Joint Statement on Broker-Dealer Custody of Digital Asset Securities. Extreme tl;dr — under U.S. securities laws, a broker-dealer who effects transactions involving digital securities has to comply with something called the Consumer Protection Rule, which applies to all securities transactions (not just tokens):

Put simply, the Customer Protection Rule requires broker-dealers to safeguard customer assets and to keep customer assets separate from the firm’s assets, thus increasing the likelihood that customers’ securities and cash can be returned to them in the event of the broker-dealer’s failure. The requirements of the Customer Protection Rule have produced a nearly fifty year track record[5] of recovery for investors when their broker-dealers have failed.

One of the things the statement notes is that the very concept of custody is fraught because having a private key doesn’t mean you have exclusive control over an asset. Also, holding a key doesn’t mean that you can reverse or cancel bad transactions (narrator — “Bitcoin doesn’t have a help desk”). Anyway, it was an interesting statement and points out a bunch of seemingly in-the-weeds but really key challenges to broker-dealer custody of things like Bitcoin. (Take for example the fact that the federal insurance regime that applies to a broker-dealer failure defines “securities” more narrowly than federal securities laws). Anyway, many of these details will have to be hashed out before broker-dealers are permitted to custody digital asset securities under federal law.

I was reminded of this statement while reading a recent sanctions order against a Colorado broker named Daniel Levine. According to the SEC, which followed a state order issued by the Colorado Division of Securities, Levine offered his brokerage and investment advisory clients an OTC bitcoin scheme involving discounted bitcoin. This was a problem for a whole bunch of reasons, including the fact that his brother was a fugitive in Europe who ran off with the client money. One of the other factors cited by Colorado and the SEC was the failure “to develop and implement a secure procedure for the transfer of funds and bitcoin, such that his brother was able to abscond with approximately $ 1.5 million in funds[.]”

In other words, here — in the wild — is a really good example of what the SEC and FINRA were talking about in their joint statement: the absence of an established process to swap the cash for bitcoin made it really easy for someone to simply take the money and run. While Levine apparently tried to make his customers whole, he ended up with a permanent bar.