The Bible, SEC crypto enforcement, and the Buttonwood Agreement

Fun fact — according to the interwebs the term “gnashing of teeth” appears no less than seven times in the New Testament. You can find an example in Mathew 8:12, in which we read that “the children of the kingdom shall be cast out into outer darkness: there shall be weeping and gnashing of teeth.” There’s also been a surprising amount of this behavior on Twitter this week, involving what some people seem to think is unequal or unexplainable ICO enforcement activity by our friends at the Securities and Exchange Commission, which has cast some ICOs into outer darkness but has in other cases taken actions mild enough to allow others to open offices in suburban Virginia.

I wrote about the Block.one settlement earlier this week, here, and why the SEC might have treated the company differently than Kik, which it is suing. While I won’t belabor the points I made in that earlier piece, there seems to be a sentiment that the SEC’s treatment of this company is, well, somehow unfair. Some wags like my friend Colin Platt (Hi Colin!) have gone so far as to suggest that the SEC in entering into this settlement has effectively confirmed that “the Howey Test no longer matters.” (If you’ve been sleeping through the last 2-3 years of crypto law news, this refers to a U.S. Supreme Court case that is used to determine when something is an investment contract and thus a security under U.S. Securities law).

While it’s a funny tweet and Colin is wonderful, I think this overstates the significance of the settlement and mistakes the role of SEC enforcement, which is not to drive people out of business but to enforce U.S. securities laws in a sane way. So, the Block.one settlement didn’t involve a fraud or misappropriation claim and it involves a substantial civil penalty.

You might (will) respond by saying “But ackshually Steve they raised several BILLION dollars so they could find this in their damn couch.” To which I respond by pointing out that these folks — who I gather many people simply don’t like, for tribal and other reasons — did build something and did sorta try to keep Americans out. It’s also worth noting that the current EOS token isn’t the ERC-20 token that was sold in the ongoing ICO. Now, look, you could make the argument that this was just a clever sleight of hand, but I’d suggest we ought to welcome creativity in enforcement that helps avoid messes and market disruption, which is what we’d have a lot of if EOS was declared a security.

On the complete other side of the ICO spectrum, the SEC announced yesterday that a final judgment had been entered in its lawsuit against PlexCorp, which involved a fraudulent multi-million dollar ICO run by a couple of people in Quebec who used their ill-gotten gains to do everything but build a crypto platform. Basically, they raised a lot of money for a thing that didn’t exist, got busted for it, and Canadian and U.S. securities regulators shut that puppy down and managed to seize about $4.8 million that will be refunded to U.S. investors. The SEC press release saves me the work of summarizing it for you and explains as follows:

On October 2, 2019, the U.S. District Court for the Eastern District of New York, entered a final judgment against PlexCorps, Lacroix, and Paradis-Royer. Pursuant to the final judgment, the Defendants, without admitting or denying the allegations in the SEC’s complaint, are enjoined from further violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule l0b-5 thereunder, and Lacroix and Paradis-Royer are additionally enjoined from participating in any digital-securities offerings. All Defendants are ordered to disgorge, on a joint and several basis, $4,563,468 in ill-gotten gains from the PlexCoin ICO plus $348,145 in prejudgment interest, and Lacroix and Paradis-Royer are ordered to each pay a $1,000,000 civil penalty. Lacroix also is permanently barred from serving as an officer or director of a publicly traded entity.

I don’t think there are too many fair-minded people out there — no matter their personal feelings about Block.one and its founders, or their projects — who say that these two projects are the same and should be treated the same way. If you set aside your loathing, you may accept that blatant fraud and a registration violation with half-baked KYC that allowed U.S. investors (in spite of stated exclusions of U.S. investors) are just not the same thing.

The SEC also announced a settlement of charges against a company called Nebulous, Inc. last week for its 2014 sale of something called “Siastock.” According to the SEC’s administrative summary, the company “said it planned to use the proceeds from the offering to develop a decentralized cloud storage network called Sia. Holders of Siastock would be entitled to receive a percentage of future revenue generated from transactions on the Sia network.” They also sold “Sianotes”, which would be convertible to Siastock, and later changed the name of Siatock to Siafunds. Anyhoo, decentralized or not, this was all an unregistered securities offering, not subject to any exemption. The SEC settled with nebulous for disgorgement of $120,000, prejudgment interest of $24,601 and an $80,000 penalty.

Why did the SEC order disgorgment here but not against Block.one? I don’t know. It does seem pretty apparent this sale of something called “stock” was actually a securities offering. And it was done by a U.S. based company with U.S. investors. Digorgement does allow for return of funds to investors (you can find rules on this here) and maybe the SEC was persuaded this wasn’t necessary in the EOS case. The bottom line is that these cases are all different and, at least in my view, different cases call for different outcomes. I’m going to use some fancy words now, because it’s Friday: Enforcement is stochastic not deterministic.

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Before I go, I also wanted to make an observation about crypto industry self-regulation, which made some news earlier this week in the form of a thing called the “Crypto Rating Council.” The notion of a self-regulatory agency setting industry standards and helping determine whether token offerings are or aren’t securities is not a terrible idea. As executed though this thing looks a bit more like an unregulated cartel that offers meaningless advisory opinions than an SRO that a body like the SEC is going to give any particular weight to.

Saying that a token is 3 or a 4 on a scale of five doesn’t really mean much, and we have no idea what the deliberative process behind that rating system is, other than … yes, it’s that old Howey Test again. 

OK, so your framework is... the Howey Test. Awesome.

What would be useful? Forgive for me oversimplifying the process a lot — this would be complicated to implement — but what *might* be interesting is an organization that takes some of the no-action letter responsibility off the SEC in the first instance, and with both SEC oversight and perhaps some delegated authority able to issue expedited no-action relief for crypto assets. That would be a heck of a lot more useful (albeit 10x more complicated to implement) than “we hereby decree you are a 3.5.”

In fairness, these things take time. The Buttonwood Agreement which took place in 1792 was an early attempt at self regulation of stock trading that in the fullness of time led to what is now one of the most important SROs in existence, the New York Stock Exchange. I'm confident that at the outset it probably looked a little half-baked. Baking does take time, so the fact that this crypto council needs some work doesn’t necessarily mean that it won’t eventually become something useful, with a little baking soda and some iteration.