It has recently come to light that a law firm is being sued for legal malpractice. While this may happen regularly, this particular instance is interesting to note for those involved in the world of blockchain.
This case sees Digital Capital Management suing Faegre Baker Daniels, as they contend that the legal firm provided them with erroneous advice.
The guidance in question stems from actions taken in 2017. When looking to set up and offer an investment fund, Digital Capital Management sought out the advice of a seasoned law firm. Their search brought them to Faegre Baker Daniels.
From here, Digital Capital Management indicates that the firm advised them that crypto-assets are not viewed as securities. As such, the investment fund would not need to be registered with the SEC.
Obviously in the eyes of the SEC, this is false. The result were various enforcement actions taken by the regulatory body against Digital Capital Management.
Regardless of where fault may lay, it was Digital Asset Management that undertook the actions in violation of securities laws. This is what matters to the SEC, and the regulatory body acted accordingly.
The ICO in question is said to have raised, roughly, $3.6M from 44 investors over the course of 4 months, in 2017. As a result, the SEC imposed orders to cease and desist, as well as a $200,000 fine. Each of which were met by the company, with an agreement that no fault is admitted.
With the actions taken by the SEC, Digital Capital management feels as though they are the victims. As such, their legal malpractice suit against the firm involves seeking compensation on various fronts (damages done, legal fees, etc.).
In documentation filed, surrounding the lawsuit, Digital Capital Management touches on the various areas in which they believe the law firm provided erroneous advice. The following points are simply a few of those listed.
- “In particular, Defendant advised Plaintiff that funds should be offered under Regulation D via Rule 506(b) as opposed to Rule 506(c).”
- “Defendant further advised Plaintiffs that Crypto Assets are not securities and to structure CAF’s and the Fund’s business accordingly.”
- “The Defendant’s advice, including but not limited to that set forth above, was erroneous”
Digital Capital Management
Founded in 2018, Digital Capital Management maintains headquarters in San Diego, California. Above all, the company operates as a manager of investment portfolios, underpinned by digital assets such as cryptocurrencies.
Managing Director, Timothy Enneking, currently oversees company operations.
Faegre Baker Daniels
With over 150years worth of history, Faegre Baker Daniels has managed to establish themselves as one of the largest law firms in the United States. The company maintains a presence in various locations around the world, including London, Beijing, Silicon Valley, and more.
Chair, and Managing Partner, Tom Froehle, currently oversees company operations.
In Other News
Over the past year, the SEC has been hard at work keeping participants in the world of blockchain in check. The following articles are just a few examples of other actions taken by the regulatory body over this time, as they look to ensure market safety for investors.
KYC/AML – Who is Proactive? Who is Under Fire?
AML (anti-money laundering) refers to the laws, regulations, and policies that are used by financial-based institutions to monitor and screen customers’ source of funds, and to ensure that the funds are obtained legally; AML acts as a deterrent for criminals wishing to hide and move illegal money.
A subset under the larger AML umbrella is KYC (know-your-client/customer). KYC is the collection of data by financial institutions to know its customers better and establish a customer profile that details a customer’s risk tolerance, financial position, and financial literacy. Documents often collected in the KYC process are notarized passports and utility bills, employment status, net worth, source and description of funds, etc. KYC is used to protect the financial institution and the customer.
While KYC/AML plays an important role in investing, not all financial institutions are equally thorough in the collection of KYC/AML data. There have been multiple companies in the digital asset industry that have come under fire for lax approaches to the KYC /AML verification process. By contrast, there are also multiple instances of companies in the digital asset industry that have taken proactive approaches.
Why are KYC and AML practices important?
While it would be nice to live in a world absent of bad actors, this is simply not reality. KYC/AML plays a role in creating safe and fair financial markets for everyone. They also provide a means of recourse against those found to be acting in bad faith.
There are drawbacks in trying to foster fair markets though – notably, a loss of privacy. Yes, honest investors may gain better safety, but they are also forced to give up vital identifying information about themselves. This is a valid concern; when giving up personal data, you are entrusting that it will be safely guarded by the receiving entity. Unfortunately, financial institutions are not immune to data breaches as recently made evident by the Canada Revenue Agency which had a breach of more than 48,500 accounts.
Despite the noted benefits of KYC/AML, there are many companies that have opted for a half-hearted approach to these practices. The following are only two recent examples in a pool of many which highlight this.
One of the largest cryptocurrency exchanges in the world, one would assume that Binance would partake in good KYC/AML practices. This, however, is not the case in the eyes of Japanese exchange, Zaif. This lesser-known exchange is now suing Binance over its ‘lax’ KYC/AML practices. The lawsuit stems around a hack of Zaif in 2018, which resulted in roughly $60M of stolen assets being laundered through Binance – an occurrence that Zaif believes would not have occurred if the KYC/AML procedures used were up to par.
In this instance, payment processor, ePayments, went under a FINRA imposed lockdown in early 2020. While the company has remained quite tight-lipped regarding the reasoning for this, it is known that the lockdown stems from a lax approach to KYC/AML. In recent days, ePayments has provided a small update, indicating that it is commencing a platform restart soon – albeit with the discontinuation of support for cryptocurrencies – after months of overhauling its KYC/AML approach.
Learning by Example
Although there are those that have not placed enough emphasis on KYC/AML, others have watched and learned from these transgressions. The following are examples of this, showing both service development, and adoption.
This recent announcement is more than just an investment. BnkToTheFuture will be incorporating a tailor built solution by Blockpass, meant to facilitate comprehensive and efficient KYC/AML procedures.
Industry leading, Securitize, recently launched a new service, dubbed ‘Securitize ID’. This service was built to bring new efficiency to KYC/AML procedures. It essentially allows for an investor to be ‘whitelisted’ after completing KYC/AML processes through Securitize. Being whitelisted involves assigning a unique investor ID, which is then recognized by co-operating companies – meaning the process does not need to be repeated countless times.
A Growing Industry
If anything can be derived from these various examples, it is that the world of blockchain needs to take KYC/AML seriously. While there may not have been services to fit these needs at one point in time, this is no longer the case. Moving forward, expect to see increased adoption of these services tailor-built for KYC/AML, as companies look to avoid the wrath of regulators, and ensure fair markets for clientele.
Nigerian SEC Provides Clarification on Token Offerings and Digital Asset Classification
Investors continue to flock towards assets such as cryptocurrencies and digital securities as, not only a new form of currency but a hedge against global economic uncertainty. As a result, regulatory bodies around the world have had to adapt or clarify approaches towards these alternative asset classes. The latest to do so is the Nigerian Securities and Exchange Commission.
Before jumping into what a few of these approaches are, the Nigerian SEC took the time to allay fears of an unnecessarily strict approach.
“Digital assets offerings provide alternative investment opportunities for the investing public; it is therefore essential to ensure that these offerings operate in a manner that is consistent with investor protection, the interest of the public, market integrity and transparency. The general objective of regulation is not to hinder technology or stifle innovation, but to create standards that encourage ethical practices that ultimately make for a fair and efficient market.”
“The position of the Commission is that virtual crypto assets are securities, unless proven otherwise.”
By taking this stance, it removes the guesswork surrounding the treatment of digital assets. Essentially, it does not matter if an asset fails to fit the definition of a security. In order to be deemed something else, this needs to be proven to the Nigerian SEC on a case-by-case basis. Only then, with the approval of the regulatory body, can an asset be reclassified.
Where the Onus Lies
In addition to establishing its position that all digital assets are to be treated as securities by default, the Nigerian SEC elaborated on where the onus lay for those looking to change the classification of an asset.
“…the burden of proving that the crypto assets proposed to be offered are not securities and therefore not under the jurisdiction of the SEC, is placed on the issuer or sponsor of the said assets.”
Essentially, the Nigerian SEC will not be taking it upon itself to classify every asset. It is the responsibility of a tokens issuer to prove the most appropriate classification.
All Token Offerings Regulated
While the first two points of clarification maintain a focus on investors, a third was made to provide clarity to companies hosting capital generation events.
These events, which include ICOs, DSOs, and IEOs, are all subject to regulation by the Nigerian SEC. There are no forms or variations that ‘skirt’ around existing regulations. As all digital assets are deemed securities by default, this classification spills over into events meant to facilitate their sale/distribution. It is stated,
“…all Digital Assets Token Offering (DATOs), Initial Coin Offerings (ICOs), Security Token ICOs and other Blockchain-based offers of digital assets within Nigeria or by Nigerian issuers or sponsors or foreign issuers targeting Nigerian investors, shall be subject to the regulation of the Commission”
In the ICO boom of 2017, companies around the world took part in these popular means of raising capital. While many were scams, there were still many well-intentioned companies that simply were not well informed. As a result, many hosted ICOs, under the impression that securities laws would not apply when this was simply not the case.
This stance by the Nigerian SEC was made in an effort to avoid this confusion moving forward. While ICOs may not be as popular as they once were, token offerings still regularly occur in the form of DSOs and IEOs.
The Nigerian SEC in its current form was founded in 1979. Much like similar regulatory bodies, it is tasked with ensuring fair and transparent capital markets through the creation and enforcement of regulations.
Chairman, Olufemi Lijadu, along with a 9 person board, currently oversees operations.
In Other News
At the beginning of today’s look at the actions of the Nigerian SEC, we alluded to similar occurrences in a variety of nations. Some of these occurrences involved real change, while others simply clarification. The following are a few examples of these.
FLiK and CoinSpark Orchestrators Charged by SEC for Fraudulent ICOs
On September 11, the SEC announced charges against FliK and CoinSpark, as well as five individuals associated with the two companies. The charges stem from two fraudulent ICOs (FliK and CoinSpark) held in 2017.
With 2020 being a disaster in many ways, it is easy to develop a short term memory of past years. Unfortunately for the bad actors that took part in past fraudulent ICOs, the Securities and Exchange Commission (SEC) remembers.
The charges surrounding these two ICOs are various. Not only did the events represent the illegal sale and distribution of securities, but they were rife with other fraudulent activity.
- Illegal sale and distribution of unregistered securities
- Appropriating and misusing investor funds
- Market manipulation
As a result of these charges, all parties have opted for a settlement with the SEC – each of which consists of restrictions on future market participation, along with fines that range from $25,000 – $75,000 USD.
The aforementioned charges are particularly noteworthy, due to the names attached to these projects. Of the 5 individuals charged, two are well-known celebrities.
Clifford ‘T.I.’ Harris – T.I. is a rapper/actor that not only promoted, and sold FLiK tokens, but also misrepresented himself as a co-owner of the project.
Ryan Felton – Primarily a film producer, Ryan Felton was the main orchestrator behind both illegal securities offerings. The SEC took the time to comment specifically on his actions, stating, “The federal securities laws provide the same protections to investors in digital asset securities as they do to investors in more traditional forms of securities…as alleged in the SEC’s complaint, Felton victimized investors through material misrepresentations, misappropriation of their funds, and manipulative trading.”
Off the Hook?
If there is one individual that may yet rest easy, and be happy with the conclusion of this saga, it would be Kevin Hart.
When the SEC first began investigating the actions of those affiliated with FLIK, Kevin Hart was among those named. Fortunately for the superstar actor/comedian, recent developments indicate that there have been difficulties proving his involvement.
For the time being, there was no mention of Kevin Hart in the SEC’s most recent communication.
Securities and Exchange Commission (SEC)
Founded in 1934, the SEC is a United States regulatory body. Its purpose is to foster fair and transparent markets, through the creation and enforcement of regulations pertaining to assets deemed securities.
Chairman, Jay Clayton, currently oversees operations at the SEC.
In Other News
When looking at some of the other high-profile cases to be settled with the SEC, news of FLiK and CoinSpark seems relatively minor. Despite this, when looking at the big picture it becomes clear that no ICOs are safe from enforcement actions by the SEC. These smaller cases discussed today are simply the latest in a long line of similar instances.
By not letting anyone ‘off the hook’, the SEC is sending a clear message moving forward that the blockchain industry needs to remain mindful of existing securities regulations, and that companies will be held accountable for their actions.