By Vernon Budinger, CFA and CAIA

September 12, 2018

Yesterday the U.S. Securities and Exchange Commission (SEC) displayed its resolve in policing the Crypto Market and announced two major enforcement actions against firms involved in the digital assets sector, the SEC’s name for Cryptocurrencies. While the SEC has announced that Cryptocurrencies such as Bitcoin and Ethereum do not fall under its purview, some Crypto Assets do qualify as securities and it is monitoring the Cryptocurrency world for violations of U.S. Securities Regulations.  (See our blog – “What Makes a Token A Security.”)  However, these rulings also apply to any firm that seeks to issue exempt securities under the rules of Regulation A+ or D. 

The first enforcement action came in the form of an order against Crypto Asset Management LP (CAM) for offering a fund that “operated as an unregistered investment company while falsely marketing it as the ‘first regulated crypto asset fund in the United States.’” *

The CAM order charged that Timothy Enneking “raised more than $3.6 million over a four-month period in late 2017 while falsely claiming that the fund was regulated by the SEC and had filed a registration statement with the agency.   However, Enneking raised the money through a unregistered, non-exempt public offering and “then invested over 40% of the fund’s assets in digital asset securities.”  This made CAM an unregistered investment company.    After receiving the order CAM, ceased the public offering and offered to buy back the shares of the fund from investors who had committed money.

CAM and Enneking complied with the cease-and-desist order and to censure without admitting to or denying the findings.  They also agreed to pay a penalty of $200,000. 

The second SEC action required that TokenLot LLC pay $471,000 in disgorgement penalties plus $7,929 in interest without admitting or denying guilt.   In addition, the firm had to hire an independent third party to destroy all its digital assets.  The action was aimed at TokenLot, “a self-described ‘ICO Superstore’ and its owners” for acting as unregistered broker-dealers.  This is the first time that the SEC has charged a firm for acting as a broker-dealer and selling digital assets.  The enforcement came after the July 25, 2017 release of the “DAO Report”  that cautioned Cryptocurrency investors and issuers that “the offers and sales of digital assets by ‘virtual’ organizations are subject to the requirements of the federal securities laws.

The TokenLot LLC action asserts that “TokenLot, Lenny Kugel, and Eli L. Lewitt promoted TokenLot’s website to purchase digital tokens during initial coin offerings (ICOs) and also engage in secondary trading.  TokenLot listed more than 200 different digital tokens and received orders from more than 6,100 purchasers of digital assets.  It is important to note that not ALL of the 200 digital tokens qualified as securities. 

TokenLot made money from charging a percentage of the money that it raised for ICOs and from trading the tokens issued in the ICOs.    TokenLot, Kugel, and Lewitt were not permitted to engage in this business since they were not registered dealers with the SEC.  The SEC was especially strict with TokenLot because it commenced operation in July 2017, the same month that the SEC issued the DAO report that informed the market that securities laws were applicable to digital assets. 

As a result of the order and the SEC investigation, TokenLot voluntarily began “winding down and refunding investor’s payments for unfilled orders.” The SEC also charged TokenLot, Kugel, and Lewitt with violating SEC registration regulations.  In addition to the disgorgement and interest penalties, Kugel and Lewitt were ordered to pay $45,000 each and agreed to be barred from the industry, penny stock market, and an investment company prohibition for three years.

The two cases reinforce the need for Crypto players (and any firm that wants to issue exempt securities) to know the law.  The SEC is not messing around.  In the September 11, 2018 press release, Stephanie Avakian, Co-Director of the SEC’s Enforcement Division, recommended that anyone developing a digital trading business enter in contact with the SEC staff at FinTech@sec.gov for assistance in analyzing possible registration requirements and the applicability of other securities laws.

*SEC Press Releases: 

CAM:  https://www.sec.gov/news/press-release/2018-186    

TokenLot LLC: https://www.sec.gov/news/press-release/2017-131