Regulation Recap: U.S. Financial Regulators Stepping Up Efforts to Clean Up the Crypto Space

Siamak Masnavi
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From a regulatory point of view, Tuesday, September 11th, 2018 was an interesting day for the crypto community because we heard about enforcement of U.S. securities laws in four separate crypto-related cases. However, some of the reporting on these stories was a bit hazy, if not misleading. And so, in this article, with the help of American lawyer Jake Chervinsky, who always provides delightful intelligent commentary on crypto-related U.S. regulatory issues, we will try to clarify what took place yesterday and what the implications are for the crypto space.

This is how Chervinsky summarized yesterday's events:

We are going to divide yesterday's news into three sections, with all commentary provided by Chervinsky (from his tweets).

USA v. Maksim Zaslavskiy (U.S. District Court, Eastern District of New York)

  • Zaslavskiy was charged in November 2017 on three counts of securities fraud in connection with two ICOs: "REcoin" and "DRC."
  • DOJ says Zaslavskiy lied to investors when he sold these ICOs. According to the indictment, he told investors that both coins were backed by real world assets: he allegedly claimed REcoin was backed by real estate & DRC was backed by diamonds.
  • In February, Zaslavskiy moved to dismiss the case, arguing that:
    • he didn't commit securities fraud because REcoin & DRC aren't securities
    • the securities laws are unconstitutionally vague because an ordinary person wouldn't have known his alleged conduct was illegal
  • Today [ED: 11 September 2018], the court denied Zaslavskiy's motion. The judge ruled that, assuming all of DOJ's allegations are true, REcoin & DRC are securities & the laws are not so vague as to be unconstitutional. This doesn't mean Zaslavskiy is guilty, it just means he will go to trial.
  • The ruling is worth a read, but doesn't say anything too surprising:
    • the federal securities laws apply to ICOs
    • ICO tokens could qualify as securities under the Howey test
    • making money by lying to investors could qualify as securities fraud
  • The ruling likely won't have much impact outside of Zaslavskiy's case. The reasoning may be persuasive, but other judges are free to ignore it if they disagree. Plus, it doesn't say "all ICOs are securities." It's limited to the facts of this case & may not apply otherwise.
  • The ruling isn't even conclusive for REcoin & DRC. It just says that the indictment isn't so deficient that it should be dismissed. A jury of twelve regular people will get to make the final decision, and they could easily decide that these ICOs aren't securities after all.

U.S. Securities and Exchange Commission (SEC)

  • Speaking of the SEC, they announced two cases today [ED: 11 September 2018], charging:
    • Crypto Asset Management("CAM") & its owner with fraud & operating an unregistered investment company
    • TokenLot & its owners with operating an unregistered broker-dealer
  • Both cases had already settled before the SEC announced them. This is typical for US government investigations. They can go on for months or years quietly & won't be announced until a resolution has been reached. Imagine how many others are going through this process now.
  • Details of the SEC order against Crypto Asset Management and Timothy Enneking:
  • Details of the SEC order against TokenLot, Lenny Kugel, and Eli L. Lewitt:
  • A couple interesting points here. First, note that a company can violate the federal securities laws & still keep doing business (if it cooperates with the SEC, anyway). CAM has to pay a $200k fine, but it gets to keep operating now that it's in compliance with the law.
  • I've mentioned this before in the context of Ripple & the possibility that the SEC is currently investigating potential violations related to XRP. It's possible to deal with securities violations without going bankrupt or to jail.
  • Second, TokenLot is the first crypto company that the SEC has sanctioned for a purely regulatory violation (I'm pretty sure). In other words, unlike all the other SEC crypto cases, nobody at TokenLot committed overt fraud. The company simply failed to register as required.
  • This signals the start of a new chapter for enforcement in crypto. The SEC is no longer focusing exclusively on obvious ponzis & scammers. They've expanded their scope to people who, despite good intentions, fail to comply with the securities laws due to negligence alone.

Financial Industry Regulatory Authority (FINRA)

  • Finally, let's touch on the Financial Industry Regulatory Authority ("FINRA"), which announced today [ED: 11 September 2018] that it charged a broker with fraud and unlawful distribution of unregistered securities.
  • FINRA may be a new acronym for some people on #cryptotwitter. It's a little different than the other regulators we often discuss. It's not technically part of the government: it's a "self-regulatory organization" authorized by Congress to govern the broker-dealer industry.
  • As for the disciplinary action that FINRA announced today, it's a fairly straightforward story of a broker who allegedly launched an ICO, lied about it, and then sold it to investors anyway.
  • FINRA's press release:
  • What's most interesting is that FINRA has never charged a case involving crypto before. Until now, the most active regulators in the space have been the SEC, DOJ, & FinCEN, but there are *so* many others who haven't jumped in yet. I'm betting FINRA is the first of many.


Chervinsky concludes his excellent analysis with the following two tweets:


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