Regulatory Compliance

Crypto has come to prominence over the last decade, and like all businesses that come about, legal regulations have not been far behind. The Securities and Exchange Commission (SEC) became active in the space in 2013 and in the first seven years of enforcement (through 2020) it has taken dozens of actions including administrative proceedings, litigation, subpoenas, administrative orders, trading suspensions of crypto currencies, and investor alerts and statements.

The seriousness with which the SEC takes cryptocurrency was displayed during the depths of the Covid-19 pandemic, as its work on the matter remained steady despite the difficulties facing the country. This was also due to the fear that economic downturn typically sees a rise in fraud, which the SEC wanted to protect citizens from. It was clear that preventing potential fraud was at the forefront of the SEC’s mind in 2020, as all its litigation alleged fraud.

Specifically, cryptocurrency offerings are often called Initial Coin Offerings (ICOs). Fraud can occur through ICOs because these offerings can be direct from the issuer as opposed to through a middleman like a tradition Initial Public Offering (IPO) on the stock market. Consumers are urged by the SEC to dig into the opportunities presented to invest in ICOs because it is easy for these companies to lie and dupe consumers. Some of the ways consumers can be duped include lying about a coin’s validity overall, promising that the coin will provide returns, stating that the coin is registered properly (or that it does not need to be).

The main question while the space was early on in development was whether ICOs were considered contracts, and did the coins being offered qualify as securities, therefore subject to stricter scrutiny. In a DAO report released in 2017, the SEC announced it would use the standard from SEC v. W.J. Howey (1946) as the benchmark, denoting that the three factors in evaluating whether a coin was a security were:

  • Is there a contract?
  • Is there an investment in a common venture?
  • Is said investment based on the expectation that profits will be derived off the efforts of others?

Expanding on the SEC’s view of cryptocurrencies, SEC Director of the Division of Corporate Finance Bill Hinman gave a speech in 2018 outlining that neither Bitcoin nor Ever are securities due to decentralization of their networks. Therefore, the greater focus in popular cryptocurrency use is on utility and coins, not securities coins. Essentially, utility coins operate within their own space (like the Bitcoin market) where the value is just within the market itself. They do not satisfy factor three of the above test because there are no profits derived off the efforts of others like what occurs with stocks in the stock markets (ex. utility coins do not provide dividends).

n 2019, the SEC further clarified its views on cryptocurrencies with its Framework for Investment Contract analysis, proclaiming that nearly all ICOs satisfy the first two factors of the Howey test and that the primary determining factor for the vast majority of ICOs is the expectation for profits derived off the efforts of others.

The SEC is not the only organization involved in trying to create regulatory framework for cryptocurrency. The Department of Justice (DOJ) has also involved itself in the area, trying to ensure the legitimacy of cryptocurrency and the prosecution of people who utilize cryptocurrency to commit criminal acts. Three of the main areas of concern for the DOJ in terms of crypto crimes are:

  • Cryptocurrency’s use for terrorism
  • Terrorist may use cryptocurrency transactions to avoid large cash transactions that would trigger bank reporting
  • Obstruction of financial activity
  • Criminals may utilize cryptocurrency to evade regulatory compliance, commit tax evasion, etc.
  • Commission of crimes within the market
  • Hackers may break into people’s digital wallets and steal their funds

While the space is still growing therefore causing concerns of uncertainty, there is also a growth of partnerships, with organizations like the DOJ and SEC partnering with other domestic and foreign agencies to help police the cryptocurrency market.

The best course of action is to consult a lawyer with expertise in the field. A Bitcoin lawyer or, more broadly, a cryptocurrency lawyer, could help you analyze if an ICO is worth investing in or if it is not a legally sound venture.

The Davis Law Firm is located in Jacksonville, Florida and serves clients throughout the states of Florida and Georgia, including Jacksonville, Miami, Pensacola, Orlando, Tampa, St. Petersburg, St. Augustine, Fort Myers, Daytona Beach, Panama City, Destin, Melbourne, Fort Lauderdale, West Palm Beach, Tallahassee, the Florida Keys, and everywhere in between.

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