[The rapid development and adoption of the crypto marketplace across institutional, corporate and retail investor markets have been growing at a speed well beyond regulatory efforts to keep up. In fact, this rapidly changing landscape has led to a flexing of regulatory muscles between different agencies in defining terms and drawing lines of authority—all while the trend toward cryptocurrency investing accelerates.
To take a deep dive into these regulatory issues, we reached out to Institute member Bo Howell, founder and CEO of Joot —a fintech company that provides web-based compliance technology and services to registered investment advisors, broker-dealers and funds. He’s also the owner of FinTech Law, a technology-driven law firm focused on financial services and technology companies. Fresh from publishing a detailed series of blog posts and articles on the crypto regulatory landscape and speaking as a panelist at last year’s NSCP National Conference, Bo offers his practical perspective and thoughts on where we are and where we are going with the evolving regulatory issues around the crypto marketplace.]
Bill Hortz: How did you personally get more involved in the cryptocurrency area?
Bo Howell: Like most people, I had heard of cryptocurrencies but had not participated in the asset class. In 2021, I had a legal client that wanted to launch one of the first mutual funds for investment primarily in Bitcoin futures. I used that opportunity to learn more about the crypto space, including some certifications from Coursera. I even took time to build a mining computer and join a mining pool. Pro tip: these energy hogs can replace a small space heater in your home! I also scored some dad points shortly after getting up to speed in this space when my 18-year-old and 13-year-old sons separately talked to me about crypto (a strong indicator that the asset class is now mainstream). They were impressed that (1) I had heard about numerous cryptocurrencies, (2) I actually owned a few and (3) I had built a mining machine!
Since late 2021, my clients and I have had numerous discussions about the crypto regulatory space with senior staff members at the SEC. I also started blogging on the topic. Since then, I’ve worked with RIAs and investment companies that are introducing cryptocurrencies as an asset class, advised startups that are looking to leverage blockchain technology in their businesses and more. Over the next few months, I will be presenting continuing education courses for lawyers on the topic, speaking at ABA events on the matter and working with Joot and FinTech Law clients to manage the regulatory landscape.
Hortz: Can you give us some examples of the types of abuses and scams that have happened in the crypto space?
Howell: Cryptocurrency is a boon for scammers because many market participants do not fully understand the underlying technology or marketplace. From October 2020 through April 2021, the FTC fielded nearly 7,000 reports from consumers about scams. The median loss reported for these scams was $1,900. The FTC cautions people interested in cryptocurrencies to look for obvious signs of a scam, such as someone insisting on cryptocurrency for payment, a guarantee you’ll make money, or a promise of guaranteed returns and big payouts. Scammers also make big claims but do not provide details about how the investment works or where your money is going.
As a result of persistent fraud in the marketplace, regulators are focusing more attention and resources on protecting investors. The SEC has brought numerous enforcement actions against players in the crypto and decentralized finance (DeFi) space. For example, the SEC settled an enforcement action against a DeFi platform and its executives for unregistered securities sales of more than $30 million and misleading investors. Blockchain Credit Partners used smart contract and DeFi technology to sell two types of digital tokens: mTokens and DMM governance tokens (DMG). The mTokens paid fixed interest and the DMG tokens purportedly gave holders certain voting and profit-sharing rights. The DMG tokens were meant for resale in a secondary market. The SEC found that the tokens were investment contracts under the Howey Test, which turns any contract, scheme, or transaction into a security if there's an investment of money in a common enterprise with a reasonable expectation of profit from the work of others. Therefore, the offerings should have been registered under the Securities Exchange Act of 1934.
More recently, the SEC brought a civil lawsuit against Ryan Ginster for engaging in two unregistered and fraudulent securities offerings. In SEC v. Ryan Ginster, the staff alleged that Mr. Ginster sold about $3.6 million in Bitcoin through multiple coin exchanges, promising unrealistic rates of return. Mr. Ginster then converted about $1 million of the Bitcoin into cash and used it to pay personal expenses. In a press release, Michele Wein Layne, regional director of the SEC's Los Angeles Regional Office, stated that “[i]ndividuals who hide behind the anonymity of cryptocurrency transactions to defraud investors should expect that the SEC will trace their illegal activity and hold them accountable for their actions.”
On December 2, 2021, the SEC brought another crypto-related enforcement action, this time for a foreign scheme that allegedly defrauded retail investors of more than $7 million in two unregistered digital asset securities offerings. This time, the case was brought by the SEC’s Cyber Unit, a specialized unit within the SEC’s Division of Enforcement. In the press release, Kristina Littman, Cyber Unit Chief, reiterated that the SEC “will continue to detect and pursue those that seek to victimize investors in the digital asset space.”
Hortz: What are the investor protection gaps regulators are most concerned with?
Howell: Last summer, SEC Chair Gary Gensler spoke at the Aspen Security Forum on the current state of U.S. crypto asset regulation. In his speech, Mr. Gensler acknowledged the contributions crypto assets and blockchain technology have made to financial and monetary innovation. But he also noted the immediate need for investor protection considering the hype, frauds, scams and abuses in the crypto asset space that have harmed investors. In particular, Mr. Gensler warned about significant investor protection gaps with respect to foreign and decentralized crypto trading platforms that fail to prohibit U.S. investors from participating. He noted that some products, such as mutual funds that invest in Bitcoin futures, include the significant investor protections provided by the Investment Company Act of 1940, but he stressed that further congressional action is needed to close regulatory gaps regarding crypto assets.