Texas is at the forefront of using its state securities laws to go after allegedly fraudulent cryptocurrency investment schemes, and as digital currency offerings grow more popular, more states are expected to follow suit, experts say.
The Texas State Securities Board found “widespread fraud” during a monthlong investigation into cryptocurrency investments, leading to seven regulatory actions with dozens more investigations open, it said in an April 10 report. The agency said it was the first state securities regulator to enter an order against a cryptocurrency firm, with a cease-and-desist order against BitConnect in January, and had entered the most orders of any state regulator.
And while Texas has been out front in recent months, other states are beginning to get in on the action. North Carolina in January barred lending and exchange platform BitConnect from operating, New Jersey went after Bitcoiin B2G in March for offering unregistered securities in connection with its initial coin offering, and in March, Massachusetts’s securities regulator issued consent orders halting five initial coin offerings.
“In terms of enforcement activity, it’s really been in the last few months that we’ve seen some action in our states,” David McGill of Kobre & Kim LLP said.
McGill said state regulators have been taking some time to get a baseline understanding of what’s happening with cryptocurrency and technical knowledge about the digital currency offerings.
“It’s taken state regulators some time to develop that understanding,” McGill said. “I think they’re now poised to be more aggressive. My expectation is this will be a hot area for regulators both at the state and federal level for the rest of 2018.”
Bitcoin skyrocketed in value in late 2017 to peak above $19,000 in December, triggering water-cooler talk across the country about how much money could be made by investing in digital currency. With all the elements of a traditional “market mania” at play, regulators grew concerned the public could be duped, Kobre & Kim’s Ben Sauter said.
Several states have issued investor alerts warning about fraudulent offerings, especially in the context of initial coin offerings or ICOs. Their warnings follow the lead of the U.S. Securities and Exchange Commission’s cautions about ICOs and investigations of the offerings.
“Look, there’s no doubt that the industry has been rife with fraud and scams,” Sauter said. “The regulators are obviously needed to curb some of the misconduct. They don’t want to stifle the innovation but have to patrol the frauds and scams.”
McGill said Texas has established itself as an industry leader in trying to curb abusive practices in the cryptocurrency arena, but other state regulators are moving in that direction. Given the wide range of states that have issued investor alerts, it’s likely even more states will start taking their own hard look at the activity happening on their home turf if they’re not doing so already, he said.
States have also explored regulating cryptocurrencies. New York set up what’s been dubbed a “BitLicense” tailored to virtual currency companies, and in February issued guidancecautioning virtual currency companies to look out for market manipulation. Meanwhile, Washington and California have worked on licensing regimes specific to virtual currencies.
Additionally, Delaware in August made it legal for entities incorporated there to use distributed ledger technology, including the blockchain technology that underpins cryptocurrency, for record-keeping and administration of stock ledgers. And Wyoming has exempted virtual currency from property tax.
Though some states have dipped their proverbial toes into the waters of regulating digital currencies, most are taking a “wait and see” approach to regulation, Jim Jalil, chair of the blockchain and cryptocurrency practice at Thompson Hine LLP, said. He said states are generally looking to the federal government for direction on a big-picture regulatory approach to virtual currencies.
In the meantime, they’re approaching cryptocurrency scammers from an enforcement perspective that targets bad actors without implicating the technology itself as problematic, he said.
“A bad actor could be in cryptocurrency or even gold — you could be selling gold that doesn’t exist,” Jalil said. “There’s bad actors in everything. Nobody’s in favor of them. Their use of technology doesn’t in any way debase the technology.”
To that end, government enforcement can be a partner with legitimate cryptocurrency industry actors to protect the underlying blockchain and distributed ledger technology, he said, adding that it’s beneficial and helpful as long as it’s not heavy-handed.
Jalil said Texas has been a leader among states by approaching cryptocurrencies with a positive eye that doesn’t stifle their use.
“I love Texas. Texas is always out in front,” Jalil, who is based in New York, said.
Texas “stepped up” to the enforcement plate and played a crucial role in exposing an alleged $2 billion cryptocurrency scam run by BitConnect, said David Silver of Silver Miller. BitConnect shuttered its lending and exchange platform weeks after a cease-and-desist order from Texas and other regulatory attention and has since been hit with investor litigation.
Silver represents investors who have lost money to frauds and accidentally became one of the most prolific lawyers working on behalf of cryptocurrency investors. He’s happy about state regulators investigating cryptocurrency offerings and other cryptocurrency-related investments and passing rules to prevent fraud. But he said private actions like the ones he litigates are still the best way for investors to get their money back.
“New York wants accountability and transparency,” Silver said. “That takes years to happen. It doesn’t happen overnight. All the people who lost money need help faster — that’s where I come in.”
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