Securities Industry Commentator by Bill Singer Esq

SEC Director Calls Awkward Football Audible During Wall Street Gamification Bowl (BrokeAndBroker.com Blog)

BlockFi Agrees to Pay $100 Million in Penalties and Pursue Registration of its Crypto Lending Product / Company also agrees to attempt to bring its business into compliance with the Investment Company Act of 1940 within 60 days (SEC Release)

Statement on Settlement with BlockFi Lending LLC by SEC Commissioner Hester M. Peirce

Disbarred Attorney Pleads Guilty To $5 Million Cryptocurrency Fraud (DOJ Release)

Suffolk Man Sentenced for Real Estate Investment Scheme (DOJ Release)

South Florida Man Sentenced to 7 Years in Federal Prison for Multi-Million Dollar Investment Scam Targeting the Elderly, and Spending Investor Money on Gambling, Jewelry, and Luxury Vehicles (DOJ Release)

SEC Settles Charges Against Silicon Valley Insider Trading Ring (SEC Release)

SEC Obtains Summary Judgment Against California Investment Adviser Charged with Stealing from Advisory Clients (SEC Release)

SEC Obtains Final Judgment Against Seyed Taher Kameli for Defrauding EB-5 Investors (SEC Release)

SEC Charges Shari'ah-Focused Online Investment Service with Misleading Clients (SEC Release)

Investment Club Treasurer Going To Prison For Two Years For Embezzling Hundreds Of Thousands Of Dollars (DOJ Release)

[F]rom March 4, 2019 until today, BlockFi offered and sold BIAs to the public. Through BIAs, investors lent crypto assets to BlockFi in exchange for the company's promise to provide a variable monthly interest payment. The order finds that BIAs are securities under applicable law, and the company therefore was required to register its offers and sales of BIAs but failed to do so or to qualify for an exemption from SEC registration. Additionally, the order finds that BlockFi operated for more than 18 months as an unregistered investment company because it issued securities and also held more than 40 percent of its total assets, excluding cash, in investment securities, including loans of crypto assets to institutional borrowers.

The order also finds that BlockFi made a false and misleading statement for more than two years on its website concerning the level of risk in its loan portfolio and lending activity.

A lot of securities lawyers will nod, "Yes, I saw this coming," in response to today's settlement with BlockFi Lending LLC ("BlockFi").  A company taking in crypto from a wide range of investors and promising returns could implicate the securities laws in several ways.  Today's settlement tags that arrangement as both an investment contract under Howey[1] and a note under Reves.[2]  On top of that, the settlement deems BlockFi an unregistered investment company.  Lurking behind the legal analysis, however, is an important question:  Is the approach we are taking with crypto lending the best way to protect crypto lending customers?  I do not think it is, so I respectfully dissent.

As an initial matter, it is difficult to understand how the civil penalty will protect investors.  BlockFi will pay the SEC $50 million, and will pay another $50 million in connection with state settlements for the same conduct.  While penalties this size are intended to deter bad conduct, here there is no allegation that BlockFi failed to pay its customers the money due them or failed to return the crypto lent to it.  BlockFi's misrepresentations about over-collateralization are serious, but the combined $100 million penalty nevertheless seems disproportionate. 

The piece of the settlement aimed at getting important information to customers is more understandable from a retail protection standpoint.  Customers who lend crypto assets to a company in exchange for a promised return should get the information they need to assess the risks against the rewards.  A company offering crypto lending services could offer that information voluntarily as a way to gain and retain customers.  For those companies that do not provide the information on their own, a self-regulatory or government regulatory framework might make sense.  Securities law is one regulatory framework through which one could force transparency.  This settlement seeks to do just that.  The Order Instituting Proceedings states that BlockFi's parent company has announced that it "confidentially submitted a draft registration statement on Form S-1."[3]  If this registration statement becomes effective, it will afford BlockFi customers helpful transparency.  But it is still worth asking whether a framework other than the securities regulatory framework might be better suited to getting customers transparency around the terms and risks of crypto lending products.

Applying the securities regulatory framework has consequences, some of which may be unfortunate.  Rather than forcing transparency around retail crypto lending products, today's settlement may stop them from being offered to retail customers in the United States.  BlockFi will not be allowed to take in any additional crypto from retail investors until the company has registered a new crypto lending product on Form S-1.  Getting an S-1 to the point where staff will declare it effective is often a months-long, iterative process.  When crypto is at issue, the timeframe is likely to be longer than it would be for more traditional filings.  

Even assuming BlockFi perseveres and prevails in the S-1 registration process, before it can restart its lending program, it has to leap through another regulatory hoop-the Investment Company Act.  The Commission has found that BlockFi operated as an unregistered investment company.[4]  Yet BlockFi cannot register as an investment company since it issues debt securities,[5] and so it needs an exemption or exclusion from registration.  The Order Instituting Proceedings also specifically discusses the market intermediary exclusion.[6]  If BlockFi seeks refuge in this rarely used exclusion, it has a challenging path to prove that it qualifies, particularly with the Commission staff's typical heightened scrutiny for crypto companies.[7]   The Commission's lack of experience with the market intermediary exclusion combined with the nature of BlockFi's business suggests that the sixty-day timeframe (even if extended an additional 30 days) allocated for BlockFi to "provid[e] the Commission staff with sufficient credible evidence that it is no longer required to be registered under the Investment Company Act"[8] is extremely ambitious.  

More importantly, what ends does this Investment Company Act exercise serve?  The Form S-1 already should satisfy the information disclosure objective at the heart of this settlement.  Finding a way not to be subject to the Investment Company Act would not seem to serve an additional protective purpose.  If the Commission believes that additional protections are needed to make up for not being covered by the Investment Company Act protections, then we could work with BlockFi under our Section 6(c) exemptive authority to craft a bespoke set of conditions that make sense in this context.[9]  The Section 6(c) process also lends itself better to public input, which seems appropriate given that today's settlement will reverberate beyond just the settling entity and will affect competing crypto lenders and their customers as well.

We often tell companies wanting to offer products that could implicate the securities laws to "come in and talk to us."  To make that invitation meaningful, however, we need to commit to working with these companies to craft sensible, timely, and achievable regulatory paths.  Working with an earnest desire to reach a prudent, properly calibrated regulatory outcome is important for a number of reasons.  First, these products matter to people.  A program that allows people-and not just affluent people-to keep their crypto assets, while still earning a return is valuable to many Americans, as evidenced by the programs' popularity in the United States to date.  The investor protection objective of today's settlement will be poorly served if retail investors are ultimately shut out from participation in these products.  Second, our process speaks volumes about our integrity as a regulator.  Inviting people to come in and talk to us only to drag them through a difficult, lengthy, unproductive, and labyrinthine regulatory process casts the Commission in a bad light and thus makes us a less effective regulator.  Third, a company that tries to do the right thing should be met across the table by a regulator that tries to get to a sensible result in a reasonable timeframe.  For the sake of the American public, our own reputation, and the companies that heed our call to come in and talk to us, we need to do better than we have so far at accommodating innovation through thoughtful use of the exemptive authority Congress gave us.

[1] SEC v. W. J. Howey Co., 328 U.S. 293 (1946).

[2] Reves v. Ernst & Young, 494 U.S. 56 (1990).

[3] BlockFi Lending LLC, Order Instituting Proceedings, ¶¶ 40, https://www.sec.gov/litigation/admin/2022/33-11029.pdf.

[4] BlockFi Lending LLC, Order Instituting Proceedings, ¶¶ 24-29.

[5] See Section 18 of the Investment Company Act of 1940, 15 U.S.C. § 80-18 (restricting registered investment companies from issuing "senior securities" which is defined to include "any bond, debenture, note, or similar obligation or instrument constituting a security and evidencing indebtedness"). 

[6] See BlockFi Lending LLC, Order Instituting Proceedings, ¶¶ 38-39.

[7] Even if it did not issue debt securities, the assets the company holds include digital assets, which the Commission staff does not like to see in fund portfolios.  See Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings (Jan. 18, 2018), https://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-011818.htm (identifying a series of questions under five broad topic headings and concluding that "[u]ntil the questions identified above can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products").  See also Staff Statement on Funds Registered under the Investment Company Act Investing in the Bitcoin Futures Market (May 11, 2021), https://www.sec.gov/news/public-statement/staff-statement-investing-bitcoin-futures-market (acknowledging the growth of the Bitcoin futures market and stating that the staff intends to "closely monitor" any mutual fund investments in Bitcoin futures).

[8] BlockFi Lending LLC, Order Instituting Proceedings, ¶ 43.b.

[9] Section 6(c) of the Investment Company Act, 15 U.S.C. § 80-6(c), provides that the Commission may conditionally or unconditionally exempt any person, security or transaction, or any class or classes of persons, securities or transactions, from any provision or provisions of the Investment Company Act, or any rule or regulation thereunder, if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Investment Company Act.

The charges against Levine and REICHENTHAL involve two fraudulent schemes.  In the first fraudulent scheme, in approximately June and July 2018, Levine induced another individual, the principal of a purported cryptocurrency escrow firm ("Individual-1"), to wire to REICHENTHAL over $3 million of funds from an over-the-counter cryptocurrency broker ("Company-1") to fund the purchase of Bitcoin after falsely telling Individual-1 that Levine would sell thousands of Bitcoin, when in truth and in fact, Levine never intended to sell Bitcoin.  After receiving the $3 million, REICHENTHAL, in turn, wired over $2 million to bank accounts in Guatemala held in the name of one of Levine's aliases.  Levine then lied to Individual-1 for days about why the deal had not worked out, the status of the purported Bitcoin, and the location of Company-1's money, which was never returned.

In the second fraudulent scheme, from approximately February 2019 to May 2019, Levine induced a Florida resident involved in brokering Bitcoin transactions ("Individual-2") to cause investors to send to REICHENTHAL over $2 million of the investors' money to fund the purchase of Bitcoin.  Again, Levine told Individual-2 that Levine would sell Bitcoin, when in truth and in fact, Levine never had any intention of selling Bitcoin to the investors. After receiving the funds from the investors, REICHENTHAL, in turn, sent over $1.9 million to bank accounts in Mexico controlled by Levine; the money was then wired to a bank account in Russia held in the name of one of Levine's aliases.  Levine then lied to Individual-2 and an investor about the status of the investors' funds, which were never returned. 

In connection with the above transactions, Levine used, among other things, various false aliases to communicate with the individuals sending funds to REICHENTHAL and foreign bank accounts held in his false names.  REICHENTHAL used bank accounts held in the name of his law firm and an attorney trust account to receive the funds and the pass them to Levine, before he or investors received the Bitcoin, contrary to REICHENTHAL's and Levine's promises.  

[K]ordrick Gibbons, 52, had a reputation with his co-workers and friends as being a savvy investor who was financially successful. From approximately 2015 through in or about 2018, Gibbons utilized this reputation to convince his co-workers to "invest" in his real estate holdings and, in exchange, Gibbons promised them lavish returns on their investments. Gibbons claimed to invest in properties, including businesses and condominiums, and that investors could realize 50% to 100% returns on their investments in as little as four to six months. Gibbons falsified documents to convince his investors that he had ownership interests in these properties. On multiple occasions, Gibbons emailed the victims documents that were inaccurate or false to deceive them into thinking he was wealthy and had multiple income-generating properties, when, in fact, he did not. The victims stated that Gibbons would make excuses as to why they had not yet received their money, all while promising that they would be paid. For instance, Gibbons often falsely suggested a bank had frozen his account in error or falsely asserted he was battling cancer.

In total, Gibbons defrauded at least 13 known victims and caused his investors to lose approximately $378,000. 

From September 2014 through April 2018, Grossman raised approximately $2.4 million in investor funds for his company, Dragon-Click Corp., by soliciting investments from elderly retirees nationwide.  Grossman told potential investors that Dragon-Click was developing an internet application that would revolutionize internet shopping by allowing a user to upload a photograph of any item the user wanted to purchase, identify all retailers offering that item for sale, provide price comparisons for that item across retailers, and provide a link to retailers' websites where the user could purchase the item.  Grossman solicited funds by falsely telling potential investors they would double, triple, or quadruple their investments, and that Dragon-Click was on the verge of being sold to a large technology company, such as Google, Apple, or Amazon, for over $1 billion.  He concealed from investors that, prior to raising funds for Dragon-Click, he had been permanently barred by the Financial Industry Regulatory Authority ("FINRA") from acting as a broker-dealer or associating with any broker-dealer firm, and that he had been permanently banned from commodities trading by the U.S. Commodity Futures Trading Commission ("CFTC"). 

Grossman falsely told investors that their investment money would be used to complete the technological development of the Dragon-Click internet application, to pay legal fees related to the patent application process, and to close the sale of the application to a large technology company.  But rather than using investors' money for any legitimate business purpose, Grossman misappropriated investors' funds for his own personal use.  Specifically, Grossman spent $1.3 million of investors' money on gambling, diamond jewelry, luxury cars, home mortgage payments, tuition payments for his children's private school education, and other personal expenditures.  For example, Grossman's unlawful expenditures included a McLaren MP4-12C, a Chevrolet Corvette, and a 4.81 carat diamond ring.

[B]rown, who served as the revenue recognition manager for Infinera Corporation, repeatedly tipped Infinera's unannounced quarterly earnings and financial performance results to his best friend, Benjamin Wylam, from April 2016 until Brown left the company in November 2017. The SEC's complaint alleged that Wylam, a high school teacher and bookmaker, traded on this information and also tipped Naveen Sood, who owed Wylam a six-figure gambling debt. Sood traded on this information and tipped his three friends, Marcus Bannon, Matthew Rauch, and Naresh Ramaiya, each of whom also illegally traded on the information.

The SEC's complaint further alleged that Bannon tipped Sood with material, nonpublic information concerning Bannon's employer, Fortinet, Inc. As alleged in the complaint, Bannon learned in early October 2016 that Fortinet was going to unexpectedly announce negative financial results. Bannon allegedly tipped this information to Sood, who used it to trade. After learning the information, Sood tipped Wylam and Ramaiya, who also traded.

The court ruled that the SEC was entitled to summary judgment on liability on all its claims, including violations of the antifraud provisions of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. The court held that: (1) the undisputed facts showed that the defendants, acting with scienter, stole money from their clients and (2) that defendants, who relied on unauthenticated documents in their opposition to the SEC's motion, failed to demonstrate any genuine issue of triable fact. The court also denied the defendants' renewed motion to stay the action given an ongoing parallel criminal proceeding.

According to the SEC's Second Amended Complaint, filed in May 2019, Kameli and his companies, Defendants Chicagoland Foreign Investment Group, LLC and American Enterprise Pioneers, Inc. ("Defendants"), claimed to at least 226 foreign investors that each of their $500,000 investments would be used to help construct a specific senior living project in the Chicago area or Florida and create at least 10 permanent full-time jobs within that project and that this would qualify each investor for a potential path to permanent U.S. residency through the EB-5 program. As alleged, some of the investors were Kameli's immigration clients. According to the SEC's complaint, rather than use investor funds solely for the senior living project for which an investor was solicited, Defendants improperly commingled and misused a portion of the approximately $88.7 million raised, which was contrary to representations to investors and the requirements of the EB-5 Program.

[F]rom September 2018 through July 2019, Wahed Invest advertised the existence of its own proprietary funds when no such funds existed, and also promised investors that it would periodically rebalance their advisory accounts, but did not do so.

The SEC's order further finds that when Wahed Invest ultimately launched a proprietary ETF in July 2019, it used its clients' advisory assets to seed the ETF without prior disclosure to clients of any conflicts of interest.

The order also finds that Wahed Invest marketed itself as providing advisory services compliant with Islamic, or Shari'ah law, including marketing the importance of its income purification process on its website. Despite these representations, the order finds that Wahed Invest did not adopt and implement written policies and procedures addressing how it would assure Shari'ah compliance on an ongoing basis.

[T]he Transport Investment Club (TIC), which had approximately 25 investing members, was formed in 1958, in the small community of Wellsboro, PA. Mann, a well-known high school math teacher and long-time friend of most of the TIC members, was elected treasurer of TIC in 1994. Mann's duties included collecting and disbursing funds, buying, and selling stocks as directed by TIC and its members, maintaining a set of books covering operations and assets, and preparing a monthly statement documenting the club's liquidating value, which was the total value of the club's stock holdings. Mann had sole control over the TIC bank account at Citizens and Northern Bank (C&N Bank) and the TIC investment accounts at brokerage firms. Funds collected at TIC monthly meetings were supposed to be used to purchase stocks in the TIC investment accounts as directed by the club members. Over the years, Mann regularly embezzled TIC's funds for his personal use rather than investing the funds. By February 2020, TIC's investments should have been worth approximately $290,614.05.  In actuality, Mann had embezzled all but $707.74 of TIC's stock holdings. For more than a decade, Mann routinely provided TIC members with fraudulent liquidation statements, which misrepresented the actual values of TIC's purported investments.  As one of the victims stated: "Mann's soulless duplicity and clear cunning fooled us all."

• Securities Industry Commentator
• Bill Singer