As the price of bitcoin rose to unprecedented levels in 2017,
regulators began focusing more enforcement resources on
cryptocurrency offerings, both at the federal and state levels. At
the state level, the Texas State Securities Board
(“TSSB”) has led the way. In late 2017, the TSSB quietly
launched an investigation into cryptocurrency offerings being made
to Texas investors. The TSSB announced the results of that
investigation last month, indicating that it had found widespread
fraud in cryptocurrency offerings. As a result of that
investigation, the TSSB has brought nine enforcement actions over a
span of less than six months. Given the growing investment in
cryptocurrencies, we expect to see continued use of enforcement
actions by the TSSB and other state regulators as one of the
principal tools to regulate this growing market.

THE TEXAS STATE SECURITIES BOARD

The TSSB is comprised of five members who are appointed by the
governor of Texas for staggered terms of six years. The TSSB
appoints a Securities Commissioner (“Commissioner”), who
is charged with administering and enforcing the Texas Securities
Act (“Act”). Broadly speaking, the Act requires the
registration of securities and the individuals and firms that sell
securities or offer investment advice in Texas. It also authorizes
periodic examinations of registered individuals and firms, as well
as enforcement actions against alleged violators of the Act.

When the Commissioner suspects that someone has violated the
Act, the Commissioner notifies the person of the alleged violation
and, within 30 days of the notice, holds a hearing to determine
whether a violation has occurred. If the Commissioner finds
evidence of a violation, the Commissioner issues a cease-and-desist
(“C&D”) order to prohibit the violation from
continuing. If the Commissioner determines that conduct threatens
immediate and irreparable public harm, the Commissioner has the
authority to issue an emergency C&D order. Such orders become
final and nonappealable unless the recipient requests a hearing
within 31 days.

In addition, the Commissioner may deny, revoke, or suspend
dealer, agent, and investment adviser registrations; impose
administrative fines; deny or revoke the registration of
securities; revoke exemptions from registration; and issue
cease-publication orders. When the Commissioner has evidence of
criminal conduct prohibited by the Act, the Commissioner refers it
to district attorneys or United States attorneys for
prosecution.

THE CRYPTOCURRENCY OFFERINGS INVESTIGATION

Starting December 18, 2017, the TSSB initiated 32 investigations
of securities offerings tied to cryptocurrencies within a four-week
span. On April 10, 2018, the TSSB released a report summarizing the
results of its investigation. Among the report’s most notable
findings were:

  • Thirty of the 32 promoters used
    websites, social media, and online advertising to market their
    investments to Texans, but none of the 32 promoters had registered
    to sell securities in Texas;

  • At least five promoters guaranteed
    returns, some as high as 40 percent per month;

  • At least six promoters attempted to
    recruit sales agents to sell their investment program without
    verifying that the sales agents were registered with the TSSB;
    and

  • Six of the offerings involved the
    payment of a “finder’s fee” or other commission to
    investors who recruited other investors, such as family or
    friends.

Importantly, the TSSB’s report stated that it is “not
regulating cryptocurrencies themselves, only the investments that
claim to use virtual currencies in an investment program.” But
what the TSSB regards as an investment scheme tied to
cryptocurrencies (as opposed to the underlying cryptocurrencies
themselves) remains to be seen. And as we describe below, in at
least one case, the TSSB claimed that a new cryptocurrency was in
fact a security and issued an order against its promoter for
failing to register it with the TSSB.

THE ENFORCEMENT SWEEP

Since the start of the TSSB investigation, the Commissioner has
issued nine C&D orders against promoters of alleged illegal or
fraudulent investments in cryptocurrency-related offerings. We
briefly describe each below.

USI-Tech

One of the first targets of the TSSB’s investigation was
Dubaibased USI-Tech Limited (USI-Tech). On December 20, 2017, the
Commissioner issued an emergency C&D order to halt
USITech’s cryptocurrency investment offering, the first such
order issued by any state securities regulator. The order stated
that neither USI-Tech’s offering nor its agents were registered
in Texas, and that the promoters were engaged in fraud.

USI-Tech marketed an investment offering known as a BTC Package
that allegedly derived its value from a “non-exclusive
interest in a series of Bitcoin mining contracts.” USI-Tech
advertised that purchasers of the BTC Packages “have enjoyed
profits of up to 150%.” Further, USI-Tech provided what was
purported to be a “binding legal opinion letter” stating
that USI-Tech was a “legal business in good standing,”
and told investors that it had “certified legal products in
the USA per the FTC.” The C&D order pointed out, however,
that the TSSB regulates the registration of securities in Texas,
not the Federal Trade Commission.

BitConnect

On January 4, 2018, the Commissioner issued an emergency C&D
order against BitConnect, a United Kingdom-based company, due to
its alleged illegal and fraudulent offering of investments in a
cryptocurrency lending program. BitConnect issued its own
cryptocurrency called BitConnect Coins. In an investment scheme
called the BitConnect Lending Program, investors purchased
BitConnect Coins and then lent their coins to others. The promoters
claimed that the program generated returns as high as 40 percent
per month. The Commissioner concluded that this investment and
others offered by BitConnect were securities that were not
registered as required by the Act. Shortly thereafter, BitConnect
announced the closure of its cryptocurrency lending and exchange
programs, citing the emergency C&D order as a
“hindrance.”

R2B Coin

R2B Coin is a company based in Hong Kong that sold a premined
cryptocurrency called r2b coin that it claimed to be “the most
stable digital currency in the world.” R2B Coin represented to
investors that r2b coin was distributed by the Williams Corp. Ltd.,
a company that it claimed was a “licensed global firm”
and “licensed securities dealer” based in Hong Kong and
Dubai. The Commissioner alleged that R2B Coin

also told investors that the r2b coin “will never go down
in value” and claimed that investors could be
“passive” and just “sit back and watch” their
investment grow. These and other allegedly false and misleading
statements led the Commissioner to seek an emergency C&D order
against R2B Coin on January 24, 2018 for misleading and deceiving
investors, and for Williams Corp. Ltd.’s failure to register to
sell securities in Texas.

DavorCoin

On February 2, 2018, the Commissioner issued an order against
DavorCoin for fraudulently offering investments in a cryptocurrency
lending program to Texans. DavorCoin allegedly promised investors
lucrative profits if they invested in a lending program based on a
new cryptocurrency called davorcoin. This lending program,
according to the TSSB, was an offer of unregistered securities
under Texas law. The order also alleged that DavorCoin committed
fraud by concealing the identity of its principals and its creators
and by making numerous false and misleading statements, including
that davorcoin could be traded like stock on popular exchanges.

Prior to the Commissioner’s order, davorcoin had a market
capitalization of approximately $67.6 million. After the order,
DavorCoin closed its lending program and the davorcoin market value
fell to virtually zero.

Investors in Crypto LLC

On February 15, 2018, the Commissioner entered an order in which
Daniel Neves, the CEO of Investors in Crypto LLC, agreed to stop
selling investments in a cryptocurrency trading program until he
and his firm register with the TSSB or qualify for an exemption.
Neves and his firm offered the investments through public
advertisements in an online financial services forum and through
popular social media platforms. The Commissioner said, in
connection with this order, that the TSSB “welcomes the
cooperation of firms that indicate they want to comply with
registration requirements.”

LeadInvest

On February 26, 2018, the Commissioner issued an emergency
C&D order against LeadInvest. LeadInvest made offers through a
website that claimed to show images of LeadInvest’s advisors
and legal team, but in reality those images were misappropriated
from other websites. Notably, LeadInvest included one image that it
claimed showed people who formed its Code of Ethics Association but
that in fact was of several former U.S. Solicitors General and U.S.
Supreme Court Justice Ruther Bader Ginsburg at a conference in
2005. Other images purportedly of LeadInvest staff were stock
images of models from other unrelated websites.

The order claims that LeadInvest illegally and fraudulently
offered at least three investment programs: a cryptocurrency mining
program; the opportunity to have a “specialist” manage
investors’ principal; and an investment program based on
lending money to LeadInvest in return for interest payments.

Financial Freedom Club, Inc., et al.

On April 5, 2018, the Commissioner entered an emergency C&D
order against Mark Moncher, a convicted felon, and his company,
Financial Freedom Club, Inc., among others. The Commissioner
claimed that the group was offering an unregistered cryptocurrency
trading program that promised to deliver 8% returns each week. As
part of the scheme, the promoters encouraged investors to file
materially false or misleading reports with financial institutions,
a criminal offense in Texas. In addition, the promoters offered
promissory notes tied to the sale of marijuana and that promised
“100% guaranteed” returns. The Commissioner charged them
with fraud in connection with the offer or sale of a security and
with failing to register to sell securities in Texas.

Bitcoin Trading & Cloud Mining Ltd.

Bitcoin Trading & Cloud Mining Ltd., also known as BTCRUSH,
is allegedly offering investments in a cloud-based cryptocurrency
mining program to Texas investors through a website. According to
an emergency C&D order dated May 8, 2018, BTCRUSH is promising
investors 4.1 percent interest per day with a “100%
satisfaction guarantee” and showing videos that falsely depict
the purported mining operations with stock video that is available
online. The Commissioner charged BTCRUSH with registration
violations, misrepresentations regarding the profitability of the
operation, and failure to disclose risks associated with
cryptocurrencies and mining operations.

Forex EA & Bitcoin Investment LLC

Also on May 8, 2018, the Commissioner issued another emergency
C&D order against Forex EA & Bitcoin Investment LLC and its
principals, who allegedly are operating a cryptocurrency-focused
investment scheme out of New York that targets Texas investors.
According to the C&D order, the company is claiming that
investments involve no risk and are guaranteed to not lose money.
The Commissioner charged the company and its principals with
registration violations and fraud in connection with a securities
offering.

LOOKING FORWARD

The cryptocurrency market shows no signs of slowing down.
Through the first quarter of 2018, cryptocurrency investments
continued at a record-setting pace, with more than $6 billion
raised through initial coin offerings alone. At the same time,
regulators continue their efforts to stamp out fraudulent offerings
to protect investors. Beyond Texas, regulators in Florida, North
Carolina, Kansas, and Massachusetts have issued warnings to
investors about potential scams involving cryptocurrencies, or
brought enforcement actions against alleged fraudsters. And
regulators in New York recently started investigating the policies
and practices of cryptocurrency trading exchanges.

We are hopeful that legislators and securities regulators in
Texas and beyond will provide clear guidance for the burgeoning
cryptocurrency market. In the meantime, however, in Texas we expect
to continue to see C&D orders as the principal tool to regulate
this market. Thus, promoters and investors alike need to be alert
to the risks inherent in offering and purchasing investment
products tied to cryptocurrencies in Texas. Promoters should take
care to accurately describe their investment programs, disclose the
risks associated with them, and register with the TSSB (unless they
qualify for an exemption). Investors need to take the time to
understand cryptocurrency offerings before investing in them and
should be skeptical of promises of outsize returns or incomplete
information about the investment product, strategy, and the
management team.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.


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