Hong Kong Securities Commission Launches Inquiry Into Seven Crypto Exchanges

On February 9, 2018, the Hong Kong Securities and Futures Commission (“SFC”) released a statement which, among other things, informs the marketplace that the SFC sent letters to seven Hong Kong cryptocurrency exchanges warning against listing instruments that qualify as “securities” under the Securities and Futures Ordinance (“SFO”) without a required license.[1]  Additionally, the SFC sent letters to seven crypto token issuers inquiring about compliance with the securities laws.

In response to the letters, most cryptocurrency exchanges and initial coin offering (“ICO”) crypto token issuers either confirmed compliance or immediately took remedial measures,  according to the SFC statement.

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Securities Class Action Lawsuits Continue to Test the “Utility” Token Sale Model

On January 30, 2018, dissatisfied crypto token purchasers filed a class action lawsuit against Paragon Coin, Inc. (“Paragon”) and founders Jessica VerSteeg and Egor Lavrov, alleging that the Paragon initial coin offering (“ICO”) violated the federal securities laws.[1]  This lawsuit follows those filed by plaintiffs against Centra, Tezos, ATBCoin, BitConnect, and Xunlei in connection with their ICOs in recent months.  One of the more high profile class action defendants is BitConnect, which is defending two class action lawsuits alleging that it sold unregistered securities and operated a Ponzi scheme.[2]  BitConnect allegedly led purchasers to believe that they would receive a 3,000% return on their investment over the course of a year.

The Securities and Exchange Commission (“SEC”) has brought a number of enforcement actions against companies and individuals for selling crypto tokens to the public without registering the sale with the SEC and for engaging in securities fraud.  All such actions have either settled outside of court or remain pending.  Now, the private plaintiffs’ bar is moving in as well and filing claims.  As these cases make their way through the courts, federal judges may soon be faced with the challenging task of running numerous  novel “utility” token products through the rigors of the Howey test analysis to determine if such products must be offered in compliance with the securities laws.[3]

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Beyond SegWit2X

Bitcoin’s Blocksize Debate: Behind the scenes of Bitcoin’s (BTC) success, a debate continues about whether to expand the leading cryptocurrency’s blocksize from 1MB to 2MB. On one side, the “Big Blockers” want to increase Bitcoin’s blocksize, allowing the cryptocurrency to realize its potential as a cash alternative and compete with traditional payment systems. On the other side, the “Decentralists” worry that increasing Bitcoin’s blocksize will create barriers to entry for miners, compromising Bitcoin’s security and welcoming government regulations that would jeopardize its censor-free qualities. A group of developers tried to settle the issue in November 2017 by increasing Bitcoin’s blocksize to 2MB with an update dubbed “SegWit2X,” but the proposal failed, proving too controversial. This post examines SegWit2X, the greater blocksize debate, and the important ramifications this debate has for Bitcoin’s future.

Please read the full client alert at reedsmith.com.

SEC Scrutinizes Pumping of Blockchain-Related Securities

The U.S. Securities and Exchange Commission (“SEC”) is continuing to increase its scrutiny of companies that might be taking advantage of investor excitement for blockchain and cryptocurrency (ICO) deals to inflate their share prices and raise funds.  On January 8, 2018, the SEC suspended trading in the securities of Hong Kong-based UBI Blockchain Internet, Ltd. (“UBI Blockchain”) through at least January 22, 2018.[1]  This action follows the SEC’s suspension of trading in the securities of The Crypto Company announced in December 2017[2] and three other blockchain-related companies in the summer of 2017.[3]

JA Energy changed its name to UBI Blockchain and announced its plans to use blockchain technology to track food and drug products in 2016.[4]  Securities in the company surged from $0.55 a share in February 2017 to $115 per share before the SEC suspended trading.  The SEC’s suspension notice explains that it issued the suspension due to questions regarding the accuracy of statements in SEC filings pertaining to UBI Blockchain’s business operations and the “recent, unusual and unexplained market activity in the company’s Class A common stock.”

The SEC also recently suspended trading in securities of The Crypto Company, which engages in consulting on blockchain technology and manages a portfolio of digital assets.[5]  Securities in The Crypto Company were trading at around $0.05 a share in September 2017, when their value began to climb and eventually reached $642 in December before the SEC suspended trading.  The SEC issued the suspension due to “concerns regarding the accuracy and adequacy of information in the marketplace about, among other things, the compensation paid for promotion of the company, and statements in Commission filings about the plans of the company’s insiders to sell their shares of The Crypto Company’s common stock.”

UBI Blockchain and The Crypto Company are not alone.  In recent months, an iced tea company, a cigar manufacturer, and a sports-bra company incorporated blockchain into their corporate names or business plans and saw meteoric rises in their share prices.[6]

It is important that public companies who announce a shift to a blockchain strategy or develop a business model around blockchain give careful thought to the required and appropriate SEC disclosure and reporting criteria.  The failure to do so could lead to unwanted suspension of trading, SEC enforcement actions, and shareholder actions.


[1] The suspension notice is available here.

[2] The notice is available here.

[3] A Reed Smith client alert on these suspensions is available here.

[4] A related article is available here.

[5] As described on the company’s website.

[6] A related article is available here.

CFTC Issues Proposed Interpretation on Retail Virtual Currency Transactions

“Virtual currencies,” such as bitcoin and ether, qualify as “commodities” under the Commodity Exchange Act (“CEA”).[1]  The extent that such products are subject to regulation by the U.S. Commodity Futures Trading Commission (“CFTC”) depends upon whether the products are traded in the spot (or cash) market, on a forward basis, or as the underlying of a futures or swap contract.

A spot transaction is an exchange of a commodity for payment where immediate delivery and payment for the commodity is typically expected to occur on or within a few days of the transaction date.  A forward transaction is an exchange of a commodity for payment where the commodity is intended to be physically delivered to the buyer rather than to solely transfer price risk but the delivery is deferred to a later date for reasons of commercial convenience or necessity.  Spot and forward transactions are typically subject only to the anti-fraud and anti-manipulation provisions of the CEA and CFTC’s regulations.

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New York Regulator’s Suit Challenging OCC Fintech Charter Dismissed as Premature

On Tuesday December 12, 2017, a federal judge dismissed without prejudice a suit filed by the New York Department of Financial Services (NYDFS) against the Office of the Comptroller of the Currency (OCC) challenging the OCC’s proposed new special-purpose fintech charter.  Judge Naomi Reice Buchwald of the U.S. District Court for the Southern District of New York held that the NYDFS suit required dismissal because the OCC has not yet reached a final decision on whether to issue special-purpose fintech charters.  However, Judge Buchwald dismissed the case without prejudice and did not make any decision on the merits of whether the OCC’s issuance of special-purpose fintech charters would exceed the agency’s powers under federal law.  To the extent that the OCC does finalize the fintech charter process and announces it is ready to accept fintech charter applications, NYDFS will likely re-file its suit.

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ICOs Must Remain Aware of Regulatory Enforcers

Digital assets, popularly referred to as “cryptocurrencies”, “coins”, and “tokens”, continue to provoke regulatory attention and create discord amongst regulators. Recent actions by the U.S. Commodity Futures Trading Commission (“CFTC”) and the U.S. Securities and Exchange Commission (“SEC”) demonstrate that activities by the issuers of tokens may draw scrutiny from either or both agencies. As new token issuance schemes hit the market every day, cryptocurrency market participants must be cautious because multiple regulatory enforcement arms are becoming increasingly active in this rapidly evolving arena.

Read our full client alert at reedsmith.com.

Security Implications for Blockchain Technology Reviewed by SEC

On October 12, 2017, the U.S. Securities and Exchange Committee (“SEC”) held an Investor Advisory Committee (“IAC”) meeting to consider, among other things, blockchain technology and the implications for securities markets.1 The meeting covered a broad range of topics relating to blockchain and distributed ledger technology (“DLT”), including initial coin offerings (“ICO”), post-trade processing, and decentralized applications. In the wake of the SEC’s recent enforcement action alleging that two recent ICOs were fraudulent,2  the SEC is cautiously and carefully approaching these topics in order to better capture the benefits of this new technology while avoiding the potential for fraud and abuse.

Read our full client alert at reedsmith.com.

ICOs Receive Guidance from Abu Dhabi FSRA

Earlier this month, the Financial Services Regulation Authority of the Abu Dhabi Global Market joined the ranks of various regulatory agencies from countries, including Australia, Canada, and the United States that have addressed ICOs, by issuing Supplementary Guidance on the regulation of ICOs and virtual currencies. The Guidance offers parameters for classifying, for legal and regulatory purposes, various types of digital assets. The Guidance is generally consistent with the product-and activity-based regulation approaches of the United States and the European Union.

Read our full client alert on reedsmith.com.

Regulatory Authorities Respond to Coin Offering Endorsements

Floyd Mayweather, a world famous boxing champion, recently used his Twitter and Instagram accounts to help a company raise more than $30 million in an initial coin offering (“ICO”).1 Other celebrities have similarly capitalized on their “influencer” status by promoting digital tokens to their Twitter and Instagram followers. Token issuers raised over $3 billion via ICOs in 2017,2 and while many are concerned about a bubble, there is no sign of a slowdown. Some reports suggest that early stage companies have raised more money via ICOs this year than through traditional early stage venture capital funding.3 This growth in new token issuances has elevated the profile and “coolness factor” of token sales, and celebrities are paying attention. As ICOs continue to grow in popularity, issuers of tokens may increasingly seek to involve celebrities in their advertising and promotional campaigns.

Read our full client alert at reedsmith.com.