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In the latest in a seemingly endless stream of U.S. Securities &amp; Exchange Commission (SEC or the Commission) pronouncements on cryptocurrency and blockchain regulation and enforcement, on March 7, 2018, the Commission warned investors about investing in “potentially unlawful” digital tokens that function like securities, and stated that some platforms are assets that may be “securities” under federal securities laws. Further, “[i]f a platform offers trading of digital assets that are securities and operates as an ‘exchange,’ as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.”[1]



The SEC said that it will “continue to focus on platforms that offer trading of digital assets and their compliance with federal securities laws.”[2] This follows last September’s announcement that the SEC was forming a cyber unit to focus on “targeting cyber-related misconduct” involving initial coin offerings (ICOs).[3]

These statements come while the SEC is intensifying its scrutiny of this space. The SEC has asked hedge funds how they are pricing cryptocurrencies and about the funds’ compliance with client fund protection regulations,[4] and has issued dozens of subpoenas and requests for information in recent months, as it “significantly ratcheted up the regulatory pressure on the” ICO market.”[5] This comes after a high-profile enforcement action suspending trading in three companies in connection with statements they made about acquiring cryptocurrency and blockchain tech assets.[6]

Given these enforcement efforts, we believe it is important for everyone involved in the cryptocurrency space to understand the nuts and bolts of an enforcement action and be prepared to respond in a thoughtful fashion.

Overview of SEC Investigations

When the SEC commences an investigation, it typically begins with an informal investigation in which it has no formal subpoena power, but instead relies on the cooperation of the relevant parties to provide information. Even an informal inquiry, however, can involve financial and reputational harm. For example, in early March, the SEC announced it was investigating an Overstock.com subsidiary for selling digital tokens, which led to a selloff in the parent company’s shares.[7]

The SEC staff may choose to close the matter following the informal investigation or to proceed with a formal investigation, which empowers the SEC to issue subpoenas for documents and testimony. While circumstances vary, we often recommend open cooperation with the SEC during the informal stage of the investigation, which may help convince its staff that there is no need to proceed with a formal investigation because they have been able to obtain the necessary information informally.

When the SEC staff concludes its informal or formal investigation, it may decide to take no further action, or it may recommend that the SEC commence enforcement proceedings. If the latter, the SEC typically provides prospective defendants with a Wells notice informing them of its intention to bring an enforcement action. The company then has the opportunity to respond to the Wells notice, explaining to the Commission why no enforcement proceeding is justified.

If the SEC chooses to proceed nonetheless, it may do so either in federal court or through administrative proceedings, where the SEC has a 90 percent success rate, as opposed to less than 70 percent success in federal courts.[8] It may also recommend criminal enforcement by a U.S. attorney’s office.

The SEC can seek penalties ranging from disgorgement and fines to bars from service as officer or director of a publicly traded company, or suspension or ban from the securities industry. There is also legal peril during the investigation process itself. For example, testifying falsely or destroying documents can result in charges of obstruction of justice.

To state the obvious, it is of paramount importance to retain securities counsel at the earliest stage of an SEC investigation so that you have an experienced hand to guide you through the process − including negotiating with the SEC staff on the scope of its subpoena, reviewing and analyzing documents to be produced to the SEC, and preparing witnesses for testimony or interviews. Responding to the subpoena without the assistance of highly experienced SEC enforcement counsel is risky; the consequences are dire.

In addition to retaining counsel, we also recommend that you:
<ul>
 	<li>Halt any automated document destruction policies and instruct employees to preserve any potentially relevant documents or information.</li>
 	<li>Ensure senior management and the board of directors are informed about the investigation.</li>
 	<li>Review your insurance policies to see if such an event would be covered.</li>
</ul>
Conclusion

An SEC investigation is exceptionally serious: A person under an investigation is at risk of losing his or her ability to serve as a director or officer of a public company, work again in the securities industry, or worse. The SEC has shown it will cast a wide net in the crypto and blockchain space, which could make any person or company operating in these industries a target. Retaining experienced securities counsel to guide you through the process is imperative.

[1] https://www.sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-platforms-trading.
[2] Id.
[3] https://www.sec.gov/news/press-release/2017-176.
[4] Following ICOs, SEC Subpoenas Cryptocurrency Hedge Funds, Bitcoin.com (Mar. 16, 2018), available at https://news.bitcoin.com/following-icos-sec-subpoenas-cryptocurrency-hedge-funds/.
[5] Jean Eaglesham and Paul Vigna, Cryptocurrency Firms Targeted in SEC Probe, Wall St. J. (Feb. 28, 2018), available at https://www.wsj.com/articles/sec-launches-cryptocurrency-probe-1519856266.
[6] In the Matter of Cherubim Interests, Inc., Order of Suspension of Trading, File No. 500-1 (Feb. 15, 2018); In the Matter of Victura Construction Group, Inc., Order of Suspension of Trading, File no. 500-1 (Feb. 15, 2018); and In the Matter of PDS Partners, Inc., Order of Suspension of Trading, File No. 500-1 (Feb. 15, 2018).
[7] Paul Vigna, Overstock.com Shares Drop on SEC Cryptocurrency Probe, Wall St. J. (Mar. 1, 2018), available at https://www.wsj.com/articles/overtstock-com-shares-drop-on-sec-cryptocurrency-probe-1519923374.
[8] Jean Eaglesham, SEC Wins With In-House Judges, Wall St. J. (May 6, 2015), available at https://www.wsj.com/articles/sec-wins-with-in-house-judges-1430965803.

SEC Investigations in the Cryptocurrency and Blockchain Industry