Fall is here, and U.S. financial regulators are well on their way to making this the worst season for criminal enforcement yet. Every year at this time, due to budgetary considerations and perhaps quotas to fill, agencies like the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC) and Department of Justice (DOJ) ramp up their enforcement against crypto’s alleged bad actors.
In September 2019, you may remember, the SEC and CFTC sued and settled with the perpetrators of EOS, the largest ($4 billion) initial coin offering of all time. In December 2020, the SEC announced it was building a case against Ripple Labs. and that two of its executives had supposedly held illegal token sales totaling over $1 billion. And every year, a slew of cases are brought against lower-profile crypto projects – for any number of reasons.
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“The SEC & CFTC end their fiscal year on September 30, so this is their last chance to score big wins they can highlight in their budget requests to Congress,” Jake Chervinsky, head of policy at the Blockchain Association, tweeted. (He’s made the point before.)
This year is no different. Within the past 10 days at least three lawsuits were filed against crypto projects. One company was accused of market manipulation, a crypto influencer was charged with failing to report income and there’s even a decentralized autonomous organization (DAO) thrown into the mix.
The SEC is often accused of regulating through enforcement rather than issuing clear guidance. While the accused projects mentioned are comparatively small, each enforcement has a legal wrinkle that analysts think could set a dangerous precedent. It seems as though in the mad dash to file cases before the end of the fiscal year, mistakes can be made.
Last week, the CFTC sued the company and founders behind the bXz protocol for allegedly enabling unregulated derivatives trading. The founders of the project settled with the agency, which, in something of a first, is also suing the Ooki DAO that was spun off to run the protocol. The trouble here is that the CFTC could be putting a bullet in the idea of “decentralizing” away governance of protocols and potentially criminalizing DAO participation.
Another case charges crypto influencer Ian Balina with allegedly failing to disclose income from a 2018 initial coin offering (ICO) called SPRK. The facts of the case are almost irrelevant, compared with the SEC’s justification for filing it. Buried in the court document is an argument that because Ethereum nodes “are clustered more densely in the United States than in any other country,” the SEC should complete oversight on everything that happens on the network.
“Rather than take on a simple case, the SEC is trying to use this to set precedent claiming that ALL OF CRYPTO is under SEC’s jurisdiction,” Adam Cochran, partner at Cinneamhain Ventures, in Canada, said on Twitter. “This is an absolutely unacceptable overstep that will have to be pushed back against aggressively.”
Finally, on Wednesday, the SEC accused fintech firm Hydrogen Technology Corp. and its former CEO, Michael Ross Kane, of unlawfully manipulating “crypto asset securities.” Hydrogen used a few methods to disperse its tokens, including an airdrop and a bounty program for those willing to shill the HYDRO token.
The complaint further alleges that Kane and Hydrogen hired a South Africa-based firm, Moonwalkers Trading, to use bots to create “the false appearance of robust market activity.” HYDRO’s market cap sits under $500,000. The SEC's release alleges that Hydrogen "reaped profits of more than $2 million as a result of the defendants’ conduct."
Both the accusation of an unregistered securities offering and market manipulation are run-of-the-mill activities in the world of altcoins. What’s different, and legally worrisome, about the Hydrogen case is the unclear language around the airdrop and rewards program.
“Companies cannot avoid the federal securities laws by structuring the unregistered offers and sales of their securities as bounties, compensation or other such methods,” said Carolyn Welshhans, the associate director of the SEC’s Enforcement Division.
“They say airdrops meet the Howey test’s ‘investment of money’ prong, even if no one makes an investment and no money changes hands,” Chervinsky tweeted, referring to a U.S. Supreme Court decision that spelled out how to define a “security.” Other lawyers noted the airdrop wasn’t “within the scope of the [SEC’s] actual Howey analysis” and the complaint seemed instead to focus on the promotional scheme.
Tyler Ostern, the CEO of Moonwalkers, agreed to pay back $36,750 in illicit gains from his bot army, and will face other civil penalties to be determined by a court. Kane, however, intends to fight the case.
“Just remember, SEC settlements are not settled law,” Chervinsky said. That may be true, but these actions also send a message and may have a chilling effect.
CORRECTION (SEPT. 29, 2022 – 21:40 UTC): Clarifies that Hydrogen reaped profits of $2 million through alleged market manipulation, not CEO Michael Ross Kane.