2022 Crypto round up

As 2022 has come to a close, it is a good time to reflect on the notable case law and enforcement actions in the digital asset space that may shape US federal securities laws. These cases have and will continue to set the stage for an active 2023.

The Securities and Exchange Commission (SEC) continued to take aim at crypto and we expect digital asset regulation to remain a priority in the near future. The SEC's Division of Enforcement nearly doubled the size of its Crypto Assets and Cyber Unit last year allocating more resources to enforcement in the crypto markets. While the SEC's theme of 2022 may have been "regulation by enforcement", the Department of Justice and private litigants also got in on the action.

Shortly before year end, the SEC charged FTX Trading Ltd. CEO and co-founder with defrauding investors through its crypto asset trading platform—FTX—with investigations of other securities law violations ongoing. The CEO of FTX and various alleged celebrity endorsers were also sued in a potential class action lawsuit for engaging in the unlawful sale of unregistered securities, deceptive and unfair business practices and participation in a civil conspiracy akin to a "Ponzi scheme." However, this is only one of many during 2022, and we will highlight a few notable ones below.

Unregistered offerings of securities

The heated dispute with Ripple Labs continues as the SEC has accused Ripple Labs Inc. and two of its executives for alleging raising over US$1.3bn through an unregistered, ongoing securities offering and misleading investors regarding its XRP token. The case centers around whether or not XRP is a security. Ripple furthers argues it did not have fair notice regarding the security classification and that the securities laws are impermissibly vague.

The SEC sued blockchain-based publishing company LBRY Inc. alleging LBRY offered and sold "LBRY Credits" or "LBC" without registering them as securities in violation of the US federal securities laws. A US District Court judge in New Hampshire ruled in November of last year that no reasonable jury could reject the SEC's claim that LBRY offered LBC as an investment in its content distribution network and therefore, securities. LBC did not sell the tokens through an initial coin offering (ICO), but instead sold LBC directly through the LBRY application. LBRY attempted to argue that LBC had utility and were able to be used as currency on the platform early on to compensate creators and incentivize users. LBRY CEO noted the judge's decision in this case "threatens the entire US cryptocurrency industry" by setting a standard that would deem "almost every cryptocurrency" a security. As this case was heard in the US First District, it does not necessarily impact any decision in the Ripple case held in the Second District. Meanwhile, Chairman Gensler has stated he believes that the vast majority of cryptocurrency tokens he has seen are securities.

More recently, in December of last year, the SEC filed a complaint against Thor Technologies for the sale of its Thor tokens as unregistered securities from its 2018 ICO. The SEC highlighted in its complaint that the Thor tokens were marketed as an investment, and Thor did not give proper disclosures to investors regarding its financial condition and ability to generate profits.

Non-fungible tokens (NFTs)

Purchasers of "Moments"—NFTs that show video clips of highlights from NBA basketball games that were promoted, offered and sold through NBA Top Shot—filed a class action lawsuit in May 2021 against Dapper Labs and its CEO arguing these Moments are unregistered securities. The complaint alleged these NFTs are securities because they meet all four prongs of the Howey test—an investment of money, in a common enterprise, with a reasonable expectation of profits, to be derived from the efforts of others. The complaint further alleged that Dapper controlled the market for these NFTs by controlling the supply of and secondary market for Moments, preventing withdrawals, and promoting the value of the NFTs. The case continued through 2022 and in August of last year, the defendants moved to dismiss arguing that Moments are not securities and instead more akin to collectible sports trading cards. The case is ongoing.

Insider trading

In July of last year, the SEC filed a complaint against a Coinbase Global, Inc. employee and two others alleging insider trading in violation of the federal securities laws. In its complaint, the SEC points to nine different crypto assets and alleges that these are all "crypto asset securities." The SEC did not, however, include these issuers as defendants nor has it brought separate actions against these issuers or platforms for securities law violations. Further, if these crypto assets are classified as securities, then the SEC also did not bring an action against Coinbase for offering trading of unregistered securities. The action has been criticized by many in the industry including CFTC Commissioner Pham herself noting this is a "striking example of regulation by enforcement."

In a similar case, a former product manager at OpenSea was charged with wire fraud and money laundering in a connection with a scheme to commit insider trading in NFTs. The defendant allegedly used confidential information about what NFTs would be featured on OpenSea's homepage to purchase dozens of NFTs in advance of their feature. Defendant argued that the NFTs are "neither securities nor commodities" (although the indictment did not make mention of security or securities) and cannot be the basis of an insider trading violation. Regardless of the classification of NFTs, we will likely see a focus going forward on insider trading and digital asset companies having in place proper trading policies.

Anti-touting

In October of last year, the SEC charged Kim Kardashian for touting on social media a crypto asset security offered and sold by EthereumMax without disclosing that she was paid for such promotion. The SEC alleged Kardashian published a post on her Instagram account regarding EMAX tokens—the "crypto asset security" being offered by EthereumMax. She did not, however, disclose that she was paid US$250,000 to make the post. The SEC found that Kardashian violated the anti-touting provision of the US federal securities law and SEC Director of the Division of Enforcement noted, "The federal securities laws are clear that any celebrity or other individual who promotes a crypto asset security must disclose the nature, source, and amount of compensation they received in exchange for the promotion." Kardashian ultimately agreed to settle with the SEC.

Given the tumultuous ride of the crypto markets in 2022, we would not be surprised to see a further ramp up in enforcement and regulatory actions with respect to US securities laws in 2023. It remains to be seen whether the theme will continue to be "regulation by enforcement" or more prospective looking guidance and rulemaking will be initiated.