Reed Smith Client Alerts

On May 28, 2021, the Securities and Exchange Commission (SEC) filed suit in the United States District Court of the Southern District of New York against five individuals for offering and selling digital investments without registering the investments as securities or registering the individuals as brokers.1 From early 2017 to early 2018, these individuals raised over $2 billion through a lending program run by BitConnect, an unincorporated organization that sold and traded BitConnect Coin (BCC), a type of cryptocurrency. The lending program maintained a referral program that awarded commission to promoters, hosted promotional events, and conducted public advertising. The SEC seeks to enjoin the individual promoters from engaging in further violations of the Securities Act2 and Exchange Act3, demands repayment of their gains, and charged them with civil penalties. Notably, the SEC did not target the operation of the cryptocurrency lending program itself––instead, the SEC focused on BitConnect’s marketing of the lending program and the organization’s failure to register its investment contracts.

Autores: Aron Izower Christine Parker Hagen Rooke Kelli Finnegan

Bitcoin

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.