The Securities and Exchange Commission is ramping up enforcement against cryptocurrency providers, as the Internal Revenue Service has also stepped up investigations and compliance efforts.
On Wednesday, the SEC announced that it had settled charges with a U.K.-based company, Blotics, that used to operate Coinschedule.com, a once-popular website that profiled offerings of digital asset securities. The SEC found the company violated the anti-touting provisions of U.S. securities laws by failing to disclose the compensation it received from issuers of the digital asset securities it profiled.
The move comes as the IRS has also stepped up its compliance efforts, adding a question at the top of the Form 1040 asking taxpayers to disclose whether they received, sold, sent, exchanged, or otherwise acquired any financial interest in virtual currency in 2020. The IRS has also received court authorization to send so-called “John Doe summons” to widely used cryptocurrency exchanges like Coinbase and Kraken seeking information about their customers’ identities.
The SEC effort is likely to ramp up enforcement under its newly installed chairman, Gary Gensler, who previously ran the Commodity Futures Trading Commission during the Obama administration, although it also was increasing under former SEC chairman Jay Clayton.
“Digital assets and cryptocurrency were on the radar, and I think they have already been assigned some offering fraud type penalty examinations, but also enforcement actions that have been filed,” said Ken Joseph, who was one of the initial supervisors of the SEC Division of Enforcement’s specialized asset management unit, and served as a senior officer in the SEC’s Office of Compliance Inspections and Examinations, and is now head of Americas compliance and regulatory consulting at Kroll, a corporate investigation and risk consulting firm. “But it has certainly intensified over the last few years under Chairman Clayton. It was clearly on the radar under Chairman Clayton. One of the areas that he was on the pulpit about was digital assets and potential fraud in that area.”
The SEC may begin scrutinizing the trendy area of non-fungible tokens, or NFTs, which have been generating intense interest ever since blockchain access to digital images and artworks began selling for millions of dollars at auction and grabbed headlines this year. In between serving at the CFTC and the SEC, Gensler taught at MIT about blockchain, digital currency, and the intersection of finance and technology.
“There is some speculation of there being a more hospitable environment for digital innovation under Chairman Gensler given his background as a professor in the area of digital IP, but I don’t think anytime soon should one expect that the commission’s focus on offering frauds and fraudulent offerings of securities, in whatever form the underlying securities are, will go away,” said Joseph. “That is central to the commission’s mission: fraud prevention.”
The SEC may be able to offer more guidance to companies about cryptocurrency and how to comply with the securities laws. “The predicate for an SEC examination or enforcement matter is going to be the finding of a security somewhere in the process, so to the extent that digital currency remains exactly that, a currency, the SEC is unlikely to have any major jurisdiction over that,” said Joseph. “The jurisdiction comes in when the digital currency, whether it’s in the form of Bitcoin, Ether, or NFT, when it really falls into the realm of being a security. The basic rule is that every security offering has to be registered or qualify for an exemption before it’s legal. The industry needs more clarity, which can be addressed by rulemaking, as to how digital assets should be treated in order to be classified as a security.”
He noted that the SEC has been applying an old, but well accepted structure for evaluating a security known as the Howey Test, which dates back to a Supreme Court case from 1946, SEC v. W.J. Howey Co., where the underlying assets were oranges and orange groves. “That framework has been used henceforth to evaluate whether a particular underlying asset qualifies as an offering of security,” said Joseph. “Some would say that framework is outdated and they’re asking for more clarity to bring it into the digital age.”
At Kroll, Joseph leads the team in the Americas that’s responsible for providing advice and support to registered investment advisors, registered investment companies, broker-dealers, and CFTC-regulated parties on their compliance needs. “Investment advisors are required to have compliance programs in place to detect and prevent violations of the rules and regs, and we advise our clients on how to operate in a compliant manner,” he said. “Another part of the practice serves as a consultant in a variety of complex securities matters, securities as regulated by the SEC, so we spend time on clients who are undergoing investigations and examinations by one or more of the regulatory bodies.”
He expects to see the SEC under Gensler’s leadership to be doing more investigations and enforcement in the new administration. “One change we’ve seen is, certainly from an investigation standpoint, more active investigations by the staff,” said Joseph. “I think with any transition from administration to administration there’s usually a little bit of a lull as the staff tries to figure out what the new commission and the new chairman's priorities would be, and I think the lull is now over. Chairman Gensler has made it very clear that he will be strong on enforcement. He just appointed the ex-Attorney General for New Jersey [Gurbir Grewal], a former DOJ official as well, as the new enforcement director. He has indicated that climate change issues are very much on the agenda, and I think the examination program also is well on course with its mission, focusing on complex securities and the like.”
He pointed to one recent case in the investment advisor space where the chief compliance officer was charged along with the advisor itself. “I think that reopens the discussion as to whether individuals in the regulated space would also be held liable for a lapse in standards that would normally just be charged against the entity,” said Joseph. “If this case is any guide, I think it’s clear that individual liability is very much back on the table.”
He also expects to see more activity at the SEC in the near future focused on special purpose acquisition companies, or SPACs, as well as de-SPAC transactions, “because of the large amount of money that went into SPAC vehicles and the large amount of money that’s in the hunt for potential acquisitions. We’ve already seen some investigations announced involving projections by companies that were involved in these SPAC transactions, and I do expect that activity to pick up steam in the near term.”
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