Gary DeWaal

The Securities and Exchange Commission and the Financial Industry Regulatory Authority brought unrelated enforcement actions against multiple defendants for disparate violations of securities laws for transactions involving digital assets. The SEC settled its two enforcement matters; the FINRA matter is pending. This is the first enforcement action charging violations of laws in connection with the offer and sale of digital assets brought by FINRA.

No Registration of Entities

In one action, the SEC claimed that Tokenlot, LLC and its two owners and operators, Lenny Kugel and Eli Lewitt, operated as broker-dealers when they solicited and sold digital assets connected with initial coin offerings that were securities, but were not registered as such with the SEC, in violation of law. The SEC claimed that the individuals promoted the company as an “ICO Superstore,” and assisted customers in private and pre-sales of ICO-issued security tokens as well as the secondary market trading of such digital assets. To resolve this matter, respondents agreed to disgorge almost $479,999, including interest, while Mr. Kugel and Mr. Lewitt also each agreed to pay fines of US $45,000, among other sanctions.

In the second action, the SEC charged that Crypto Asset Management, LP and Timothy Enneking, CAM’s founder and sole principal, unlawfully operated a fund – Crypto Asset Fund, LLC – that invested more than 40 percent of its value in digital assets that were securities without complying with applicable law. The SEC charged that the sale of interests in CAF without the interests being registered as a security or an exemption being available was unlawful, as was CAF operating as an investment company without being registered as such. The respondents were also charged with making false or misleading statements to investors. To resolve this action, respondents agreed to pay a fine of US $200,000 among other sanctions.

Unregistered Security

FINRA commenced a disciplinary proceeding against Timothy Ayre, for trying to attract investors to purchase shares in a worthless company he owned and served as president – Rocky Mountain Ayre, Inc. (“RMTM”) – by making material misstatements in public filings, and by unlawfully offering to the public digital assets – HempCoins – that he claimed were backed by RMTM common stock. FINRA charged that the sale of HempCoins was unlawful as they were unregistered securities that were not eligible for any exemption. FINRA also claimed that Mr. Ayre engaged in private securities transactions involving RMTM while employed by a broker-dealer without disclosing such transactions to his employer, in violation of the firm’s written supervisory procedures.

In other developments regarding digital assets:

Stablecoins. The New York State Department of Financial Services approved Gemini Trust Company LLC and Paxos Trust Company LLC to each offer cryptocurrencies pegged to the US dollar. Each cryptocurrency must be supported by one US dollar held by the relevant NY limited purpose trust company, and each company must comply with various enumerated conditions in connection with their authorization; and

BitGo. BitGo announced that it has received a license as a South Dakota Trust Company by the South Dakota Division of Banking. The company claims that it is the first qualified custodian for storing digital assets.

Compliance Weeds: Under FINRA rules, no registered person may be directly or indirectly employed in any other capacity in a business activity outside the scope of his or her relationship with his or her member firm unless he or she has given prior written notice to the member. (Click here to access FINRA Rule 3270.) Additionally, a person associated with members must also provide advance written notice to his or her employer if he or she may engage in a securities transaction outside the regular course or scope of his or her employment, including new offerings of securities which are not registered with the SEC, subject to various exceptions and conditions. (Click here to access FINRA Rule 3280.)

Earlier this year, Arthur Meunier a/k/a Arthur Breitman agreed to be suspended for two years from association with any FINRA-regulated broker-dealer to settle FINRA charges that, from February 2014 to April 2016, he participated in the development of Tezos, a blockchain technology project, without notifying the broker-dealer he was then employed by of such activity, as required by FINRA rules. (Click here for background in the sub-article “FINRA Fines a Tezos Co-Founder” in the April 22, 2o18 edition of Bridging the Week.)

FINRA’s action against Mr. Ayre also includes an allegation that he engaged in private securities transactions without notifying the broker-dealer he worked for at the time.

FINRA’s inclusion of an additional charge against Mr. Ayre for his engagement in private security transactions involving RTMN while employed by a broker-dealer that required disclosure of such transactions by its written supervisory procedures is another implicit warning to firms that it is best to ensure they have WSPs that track applicable FINRA rules regarding outside business activities and private securities transactions, and that they remind their associated persons that these requirements apply to transactions involving security tokens as well as business activities involving all digital assets, in addition to traditional securities and business activities.