February 17, 2019

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SEC Blockchain and Crypto Update

The SEC has been busy over the past couple of weeks addressing blockchain and crypto-related issues.

ETF Activity

The SEC rejected, for a second time, a request by the Winklevoss brothers for a Bitcoin exchange-traded fund. The primary reason given by the SEC was that the submission did not sufficiently explain how the ETF would prevent manipulation and fraud. The SEC has previously expressed additional concerns with crypto ETFs over liquidity, price manipulation and custody. Interestingly, the SEC Commissioner Hester M. Peirce voiced a strong dissent to the rejection, saying the rejection “sends a strong signal that innovation is unwelcome in our markets, a signal that may have effects far beyond the fate of bitcoin eTPES.”

The Winklevoss brothers are not the only folks interested in a crypto ETF.

The SEC announced that it was delaying until September 21 a decision on another Bitcoin ETF request that was filed for the Direxion ETFs. Arca Inc. filed a request for rule change in January of this year seeking approval to trade five BTC ETFs. The SEC said it was appropriate to delay its review in order to have sufficient time to consider this proposed rule change.

Despite the lack of positive results on ETF requests, Bitwise is joining the fray. It filed a request with the SEC for its own crypto-based ETF. Bitwise has proposed an ETF called, HOLD10 Cryptocurrency Index. As the name implies, it will include 10 cryptocurrencies that track Bit Wise’s HOLD 10 Private Index Fund launched last year.

Investigations and Enforcement Activity

The SEC charged an attorney and law firm business manager with illegal sales of blockchain stock. According to the complaint, the duo made approximately $1.4 million by selling shares in UBI Blockchain Internet Ltd. over a 10-day period from Dec. 26, 2017 to Jan. 5, 2018. The sales stopped when the SEC temporarily suspended trading in UBI Blockchain stock earlier this year due to concerns about the accuracy of assertions in its SEC filings and unusual and unexplained market activity.

According to an SEC statement: “This case is a prime example of why the SEC has warned retail investors to be cautious before buying stock in companies that suddenly claim to have a blockchain business. This case involved both a trading suspension and people holding restricted shares who attempted to profit from the dramatic price increase with illegal stock sales that violated the registration statement.”

Consistent with its previously issued guidance on company disclosures, the SEC has subpoenaed documents from Long Blockchain. Reminiscent of companies adding “.com” their names in the early days of the internet, Long Blockchain, a beverage maker, made news last year when it changed its name from Long Island Ice Tea to Long Blockchain, which caused its stock to spike and then later crash. It was subsequently delisted from the NASDAQ in April of this year.

The SEC has made clear that it is ”looking closely at the disclosures of public companies that shift their business models to capitalize on the perceived promise of distributed ledger technology.”

Long Blockchain disclosed the July 10 subpoena in an 8-K submitted on July 26. A similar subpoena was issued to Riot Blockchain a while ago. These investigations appear to be ongoing. We will continue to monitor this issue. In the interim, be careful about renaming a company to include blockchain without sufficient business justification and clear disclosures.

On another front, the SEC has focused on the crypto-related business practices of several brokerages. Apparently, the inquiry is focusing on fees generated from trading, financing and initial coin offerings. Previous reports indicate that The Financial Industry Regulatory Authority (FINRA) and the National Futures Association (NFA) are also looking into these issues.

These actions continue to demonstrate that the regulatory watchdogs are focused on cleaning up the fraud and other sharp business practices in the industry. Adopting best practices and ensuring regulatory compliance are no longer optional in the crypto world.

Copyright © 2019, Sheppard Mullin Richter & Hampton LLP.


About this Author

James Mattinson Blockchain Technology and Digital Currency Lawyer Sheppard Mullin Washington DC

Jim Gatto is a partner in the Intellectual Property Practice Group in the firm's Washington, D.C. office. He is also Co-Team Leader of the firm's Digital Media Industry and Social Media and Games Industry Teams, Blockchain Technology and Digital Currency team, and Team Leader of the firm's Open Source Team. 

Areas of Practice

Mr. Gatto leverages his unique combination of nearly 30 years of IP experience, business insights and attention to technology trends to help companies develop IP and other legal...