SEC Brings First Case Against Crypto Lending Platform02.15.2022
The Securities and Exchange Commission charged BlockFi Lending LLC (BlockFi) with failing to register the offers and sales of its retail crypto lending product. In this first-of-its-kind action, the SEC also charged BlockFi with violating the registration provisions of the Investment Company Act of 1940. To settle the SEC’s charges, BlockFi agreed to pay a $50 million penalty, cease its unregistered offers and sales of the lending product, BlockFi Interest Accounts (BIAs), and attempt to bring its business within the provisions of the Investment Company Act within 60 days. BlockFi’s parent company also announced that it intends to register under the Securities Act of 1933 the offer and sale of a new lending product. In parallel actions announced today, BlockFi agreed to pay an additional $50 million in fines to 32 states to settle similar charges.
To settle charges, BlockFi will pay $100 million in penalties and has agreed to significant undertakings:
— U.S. Securities and Exchange Commission (@SECGov) February 14, 2022
“This is the first case of its kind with respect to crypto lending platforms,” SEC Chair Gary Gensler said. “Today’s settlement makes clear that crypto markets must comply with time-tested securities laws, such as the Securities Act of 1933 and the Investment Company Act of 1940. It further demonstrates the Commission’s willingness to work with crypto platforms to determine how they can come into compliance with those laws. I’d like to thank and commend our remarkable SEC staff and state regulators for their efforts and collaboration on this settlement.”
“Crypto lending platforms offering securities like BlockFi’s BIAs should take immediate notice of today’s resolution and come into compliance with the federal securities laws,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “Adherence to our registration and disclosure requirements is critical to providing investors with the information and transparency they need to make well-informed investment decisions in the crypto asset space.”
According to the SEC’s order, from March 4, 2019 until today, BlockFi offered and sold BIAs to the public. Through BIAs, investors lent crypto assets to BlockFi in exchange for the company’s promise to provide a variable monthly interest payment. The order finds that BIAs are securities under applicable law, and the company therefore was required to register its offers and sales of BIAs but failed to do so or to qualify for an exemption from SEC registration. Additionally, the order finds that BlockFi operated for more than 18 months as an unregistered investment company because it issued securities and also held more than 40 percent of its total assets, excluding cash, in investment securities, including loans of crypto assets to institutional borrowers.
The order also finds that BlockFi made a false and misleading statement for more than two years on its website concerning the level of risk in its loan portfolio and lending activity.
We have entered into a landmark resolution with Federal and State regulators that provides clarity on and a pathway forward for crypto interest-bearing securities. pic.twitter.com/raIikoTNE6
— BlockFi (@BlockFi) February 14, 2022
Without admitting or denying the SEC’s findings, BlockFi agreed to a cease-and-desist order prohibiting it from violating the registration and antifraud provisions of the Securities Act and the registration provisions of the Investment Company Act. BlockFi also agreed to cease offering or selling BIAs in the United States.
The SEC’s investigation was conducted by Gwen Licardo, Craig Welter, and Kenneth Gottlieb, with assistance from Brent W. Wilner, under the supervision of Hane L. Kim, Chief of the Retail Strategy Task Force; Lara Shalov Mehraban, Associate Regional Director of the SEC’s New York Regional Office; and Kristina Littman, Chief of the Cyber Unit. The SEC appreciates the assistance of state regulators that are members of the North American Securities Administrators Association.
The SEC’s Office of Investor Education and Advocacy and Enforcement’s Retail Strategy Task Force has issued an Investor Bulletin on Crypto Asset Interest-bearing Accounts. Investors can find additional information about crypto assets at Investor.gov.
Statement from Hester Peirce, SEC Commissioner:
A lot of securities lawyers will nod, “Yes, I saw this coming,” in response to today’s settlement with BlockFi Lending LLC (“BlockFi”). A company taking in crypto from a wide range of investors and promising returns could implicate the securities laws in several ways. Today’s settlement tags that arrangement as both an investment contract under Howey and a note under Reves. On top of that, the settlement deems BlockFi an unregistered investment company. Lurking behind the legal analysis, however, is an important question: Is the approach we are taking with crypto lending the best way to protect crypto lending customers? I do not think it is, so I respectfully dissent.
As an initial matter, it is difficult to understand how the civil penalty will protect investors. BlockFi will pay the SEC $50 million, and will pay another $50 million in connection with state settlements for the same conduct. While penalties this size are intended to deter bad conduct, here there is no allegation that BlockFi failed to pay its customers the money due them or failed to return the crypto lent to it. BlockFi’s misrepresentations about over-collateralization are serious, but the combined $100 million penalty nevertheless seems disproportionate.
Thoughts on the BlockFi settlement: https://t.co/F80R8BkXjT
— Hester Peirce (@HesterPeirce) February 14, 2022
The piece of the settlement aimed at getting important information to customers is more understandable from a retail protection standpoint. Customers who lend crypto assets to a company in exchange for a promised return should get the information they need to assess the risks against the rewards. A company offering crypto lending services could offer that information voluntarily as a way to gain and retain customers. For those companies that do not provide the information on their own, a self-regulatory or government regulatory framework might make sense. Securities law is one regulatory framework through which one could force transparency. This settlement seeks to do just that. The Order Instituting Proceedings states that BlockFi’s parent company has announced that it “confidentially submitted a draft registration statement on Form S-1.” If this registration statement becomes effective, it will afford BlockFi customers helpful transparency. But it is still worth asking whether a framework other than the securities regulatory framework might be better suited to getting customers transparency around the terms and risks of crypto lending products.
Applying the securities regulatory framework has consequences, some of which may be unfortunate. Rather than forcing transparency around retail crypto lending products, today’s settlement may stop them from being offered to retail customers in the United States. BlockFi will not be allowed to take in any additional crypto from retail investors until the company has registered a new crypto lending product on Form S-1. Getting an S-1 to the point where staff will declare it effective is often a months-long, iterative process. When crypto is at issue, the timeframe is likely to be longer than it would be for more traditional filings.
Even assuming BlockFi perseveres and prevails in the S-1 registration process, before it can restart its lending program, it has to leap through another regulatory hoop—the Investment Company Act. The Commission has found that BlockFi operated as an unregistered investment company. Yet BlockFi cannot register as an investment company since it issues debt securities, and so it needs an exemption or exclusion from registration. The Order Instituting Proceedings also specifically discusses the market intermediary exclusion. If BlockFi seeks refuge in this rarely used exclusion, it has a challenging path to prove that it qualifies, particularly with the Commission staff’s typical heightened scrutiny for crypto companies. The Commission’s lack of experience with the market intermediary exclusion combined with the nature of BlockFi’s business suggests that the sixty-day timeframe (even if extended an additional 30 days) allocated for BlockFi to “provid[e] the Commission staff with sufficient credible evidence that it is no longer required to be registered under the Investment Company Act” is extremely ambitious.
More importantly, what ends does this Investment Company Act exercise serve? The Form S-1 already should satisfy the information disclosure objective at the heart of this settlement. Finding a way not to be subject to the Investment Company Act would not seem to serve an additional protective purpose. If the Commission believes that additional protections are needed to make up for not being covered by the Investment Company Act protections, then we could work with BlockFi under our Section 6(c) exemptive authority to craft a bespoke set of conditions that make sense in this context. The Section 6(c) process also lends itself better to public input, which seems appropriate given that today’s settlement will reverberate beyond just the settling entity and will affect competing crypto lenders and their customers as well.
We often tell companies wanting to offer products that could implicate the securities laws to “come in and talk to us.” To make that invitation meaningful, however, we need to commit to working with these companies to craft sensible, timely, and achievable regulatory paths. Working with an earnest desire to reach a prudent, properly calibrated regulatory outcome is important for a number of reasons. First, these products matter to people. A program that allows people—and not just affluent people—to keep their crypto assets, while still earning a return is valuable to many Americans, as evidenced by the programs’ popularity in the United States to date. The investor protection objective of today’s settlement will be poorly served if retail investors are ultimately shut out from participation in these products. Second, our process speaks volumes about our integrity as a regulator. Inviting people to come in and talk to us only to drag them through a difficult, lengthy, unproductive, and labyrinthine regulatory process casts the Commission in a bad light and thus makes us a less effective regulator. Third, a company that tries to do the right thing should be met across the table by a regulator that tries to get to a sensible result in a reasonable timeframe. For the sake of the American public, our own reputation, and the companies that heed our call to come in and talk to us, we need to do better than we have so far at accommodating innovation through thoughtful use of the exemptive authority Congress gave us.
Source: Hester Peirce
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