BitConnect was founded in 2016 as a provider of BCC. From November 2016 to January 2017, BitConnect sold approximately 5 million BCC tokens in a series of initial coin offerings. In January 2017, BitConnect launched the “BitConnect Exchange,” a digital asset trading platform allowing users to trade BCC for Bitcoin and vice versa.4 At the same time, BitConnect launched its lending program, giving investors “the opportunity to earn daily interest payments by essentially tendering Bitcoin to BitConnect in return for ‘interest’ payments.”5 The program required that an investor create a BitConnect account and transfer Bitcoin to an address provided by BitConnect. The investor would then have the option to use Bitcoin to purchase BCC, which would trigger daily interest returns from a volatility trading bot. Receiving the interest returns required transferring and converting the funds several times through the BitConnect Exchange.
In January 2018, the Texas State Securities Board and North Carolina Secretary of State Securities Division issued cease-and-desist orders to BitConnect. Shortly after, BitConnect closed its lending program, BCC lost 92% of its value and investors lost “all or nearly all” of their investments.6
The SEC contends that (1) BitConnect’s lending program investments had the characteristics of securities offerings and were therefore required to be registered with the SEC and (2) the individual promoters of the lending program were profiting from these investments and were therefore required to register as broker-dealers with the SEC.
Citing Howey, the complaint states that BitConnect and BitConnect promoters and investors were part of a common enterprise. A reasonable expectation of profit emerged from the organization’s promise, publicly advertised on its website, to pay up to 40% in interest each month “with no risk.”7 As a result, the lending program had features of an investment contract, and therefore should have been made available to investors as part of a securities offering under Section 5 of the Securities Act.
Further, four of the individual defendants promoted the program to potential investors by publishing videos to YouTube and attaching referral links to BitConnect’s website. In return, BitConnect awarded referring individuals up to 7% commission for new investments. In addition to publishing YouTube videos, defendants advertised the lending program on BitConnect’s website, on another public and popular digital asset website, and through targeted digital advertisements. These actions indicate that the individuals were serving as unregistered securities brokers and therefore violated Section 15(a) of the Exchange Act.
The fifth individual defendant “aided and abetted BitConnect’s unregistered offer and sale of these securities” by serving as a liaison between BitConnect and its promoters and by attending international promotional events for the organization.8
The SEC’s action here is yet another reminder that traditional securities activities, even in the form of digital assets, are securities that must be registered with the SEC.9 Additionally, if an individual is “actively soliciting investments” and “receiving transaction-based compensation,” in connection with a digital securities offering, that individual is likely to be recognized as a broker and must register with the SEC. As noted above, the SEC did not take issue with the general operation of a cryptocurrency lending program, which are growing in popularity with cryptocurrency market participants. However, any lending program involving securities should only be conducted after proper registration of the securities and market participants offering such programs.
- SEC v. Brown et al., No. 21-cv-04791 (S.D.N.Y. May 28, 2021).
- Section 5 of the Securities Act of 1933 requires that issuers of securities register all non-exempt offerings and sales of those securities with the SEC.
- Section 15(a) of the Securities Exchange Act of 1934 requires that brokers of securities register with the SEC or be associated with a brokerage firm that is registered with the SEC.
- SEC v. Brown, at 9.
- Id.
- Id. at 34.
- Id. at 10.
- Id. at 2.
- Id. at 7.
Client Alert 2021-165
