SEC Cracks Down On Illegal Schemes; Investigations Halt Coin 2.0 Momentum

Hundreds of Bitcoin companies that have released unregistered securities on Counterparty, Cryptostocks have been sent inquiry letters by the SEC.

The SEC is asking companies to voluntarily hand over any documentation that they have regarding their unregistered securities offerings. Photo: Egor Pavlovich/Coinspeaker

The SEC is asking companies to voluntarily hand over any documentation that they have regarding their unregistered securities offerings. Photo: Egor Pavlovich/Coinspeaker

The Securities and Exchange Commission (SEC) has sent inquiry letters to Bitcoin companies that have released unregistered securities on Counterparty and Cryptostocks.

The SEC is asking the targeted companies to voluntarily turn over any documentation that they have with respect to unregistered securities offerings.

Erik Voorhees, a co-founder of  Coinapult, claims that he was the first entrepreneur in the virtual currency space who the SEC targeted when he was ordered to pay $50,000 in fines for initiating an unregistered stock offering related to SatoshiDice.

The case brought by the SEC charged Voorhes with violating Sections 5(a) and  5(c) of the Securities Act, which “prohibit the direct or indirect sale of securities, offer to sell or offer to buy securities through the mails or interstate commerce unless a registration statement has been filed or is in effect.” Since no registration statement or notice had been given to the SEC, the regulator was within legal rights to fine Voorhess.

Voorhess got off lightly considering that he could have been charged legally with a fine of up to half the dollar amount he raised from investors. Voorhees got off so lightly in part because no investors ended up out of pocket. In fact, Vorhees personally rewarded investors who participated in the illegal financial scheme with returns of over $2.5m, representing a return of nearly 400%. Vorhees cashed his investors out at such a premium by using personal profits he made on the rising value of bitcoin between mid-August 2012, when the offer began, and the end of last year, when he ceased raising capital.

Technically, Vorhees could have been fined around $350,000 by the SEC, since the regulator is empowered to cease up to $50,000 for violating part (a) of the code, and up to half the capital raised illicitly in fines for violating part (c). The latter governs interstate and electronic and mail transmission of documents for the purposes of offering equity securities to the public.

Coins 2.0 Companies Await Judgement

The Vorhees fine has shaken the bitcoin community, despite the fact that the unregistered Satoshi Dice capital raising was an open-and-shut case of a violation of US securities laws, and would also have been illegal in most countries today, including Britain, the Isle of Man and Japan, which are considered more politically accommodating of the digital currency.

Now the attention has shifted to companies that are using enhanced virtual currencies as substitutes for equity in fundraising.

Exchange provider mcxNOW site, which is popular with the dogecoin community, has announced abruptly that it is shuttering its doors and is threatening to destroy any virtual currency units that users do not transfer away from its servers. It is thought that this has been to deflect regulator attention.

The exchange’s management cited the requirement “to address some issues concerning wallet use and the number of system administrators able to resolve problems” for the temporary blackout.

The SEC is also targeting more establish virtual currency platforms with headline VC funding. Counterparty, Cryptostocks and the media outlet Bitcointalk have all allegedly been contacted by the SEC and asked whether they illegally offered unregistered securities to the public at any time. This in itself does not bode well for the prospective defendants: the SEC typically only establishes formal contact in this way if the agency already has more than enough information to find the targeted enterprise guilty of violating the regulations.

While lawyers defending the executives who run popular bitcoin service providers such as Counterparty claim that any funds raised via the issuance of Coins 2.0 units will categorically fall outside of the juristiction of the SEC, the reality is less black and white.

This week, the Financial Crimes Enforcement Network (“FinCEN”) has clarified previous guidance in a way that potentially makes it easier for the SEC to prosecute without the mountain of evidence that it is usually required of the agency to bring on the accused.

FinCEN maintains that virtual currencies, while not legal tender, may in fact be used to represent a form of legal tender which is wrapped up in a scheme (this would make it in effect very similar or identical to an equity security, which is what the SEC needs to fast-track any case filed against offenders):

In particular, virtual currency does not have legal tender status in any jurisdiction. This guidance addresses "convertible" virtual currency. This type of virtual currency either has an equivalent value in real currency, or acts as a substitute for real currency.

The likelihood is that many of the Coin 2.0 fundraising campaigns, while methodically different to Vorhees’ illegal capital raise, are fundamentally and structurally built of the same substance: raising money without permission from regulatory authorities. The reality is that companies using this method to raise large sums of funds can expect worse to come, and so can Counterparty and bitcointalk, shortly, too.

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