By Austan Wellman

On November 2, 2022, news broke of potentially the largest corporate scandal in the United States since the likes of Enron and Lehman Brothers. This, as most are aware by now, is the current drama unfolding involving Sam Bankman-Fried (commonly referred to as “SBF”) and his cryptocurrency exchange FTX and hedge fund Alameda Research. SBF has since been arrested and is facing eight counts of criminal fraud and conspiracy, which includes securities fraud.

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By Austan Wellman Fargo Patent & Business Law, PLLC

With more news undoubtedly to follow, investors, venture capitalists, and others will wait on bated breath on how the U.S. Securities and Exchange Commission (“SEC”) will react in both punishment towards SBF and his companies, but also the likely implementation of new security laws and regulations for capital investments, especially in the crypto space. This article does not seek to opine on what the future holds for FTX or securities law, but rather to inform those seeking potential capital investments to think twice about possible securities issues before accepting an investment.

So, what is a Security?

A Security is a fungible, negotiable financial instrument that holds some type of monetary value. Securities generally fall under two broad categories: equity and debt. Equity securities commonly come in the form of capital stock which represent an ownership interest held by a shareholder in an entity. Debt securities represent borrowed money that must be repaid, and generally take the form of corporate and government bonds, certificate of deposits (CDs) and collateralized securities (such as a CDO). What many do not realize is that even a loan or a promise to pay a part of profits is considered a security as well. In cases of uncertainty of whether a security exists the U.S. Supreme Court has determined that an investment contract exists when there is, “an investment of money in a common enterprise with the expectation of profit to be derived from the efforts of others.”

Who regulates Securities?

The U.S. Securities & Exchange Commission is an independent federal agency created under the Securities Exchange Act of 1934 in response to the aftermath of the Wall Street Market Crash of 1929. The SEC’s primary mission is to enforce the law against market manipulation in accordance with the Securities Act of 1933 (commonly known as the “Securities Act”). The SEC serves as a centralized location for all companies to register their security offerings. In concurrence with the SEC, many states have formed their own state securities departments in charge of overseeing statewide security offerings. Like the SEC, state departments oversee the registration of securities offered by companies within the state and can enforce civil penalties against those who do not comply with state law. North Dakota’s securities laws can be found under North Dakota Century Code section 10-04.

So, where does Cryptocurrency fit in?

That’s the million-dollar legal question and one that is still being tested. For now, the SEC has been vocal in stating that it considers cryptocurrencies to be securities. SEC Chair Gary Gensler in recent months has voiced displeasure over the crypto market and its current regulatory state. In a September 8, 2022, statement, Chairman Gensler stated that “Promoters are marketing, and the investing public is buying most of these tokens, touting or anticipating profits based on the efforts of others.” Thus, it appears that the primary concern of the SEC is how these cryptocurrencies are being promoted to potential investors and are considered on a case-by-case basis.

Arguably, Bitcoin, the largest and most well-known digital asset, may not be considered a security. Bitcoin was created by Satoshi Nakamoto, a pseudonym of an unknown person or persons. Bitcoin does not exist for the purpose of raising money for a particular project. Based on this lack of a direct purpose or promotion, the SEC tends to view Bitcoin as not being a security.

On the other side of the digital token, cryptocurrencies like SafeMoon and FTT (FTX’s self-created crypto token) were created and promoted to the public as investments with the potential of large profits. SafeMoon was promoted as a stable token with “to the moon” potential. Yet, this past summer, SafeMoon’s value returned to orbit and crashed landed. Customers lost millions of dollars and filed a class action lawsuit against the creators of SafeMoon for fraudulent misrepresentations. Similarly, FTX’s FTT token has likewise been discovered to be worthless, causing customers to lose billions of their funds due to the company’s alleged fraudulent activities.

I’m a North Dakota business with potential investors, what should I do?

All companies must register with the SEC prior to or in concurrence with the offering of a security. During this process, the company must provide details about the proposed offering as well as detailed information about the company itself to the investor(s). The required information to be disclosed includes details about the company’s management, business, assets and financial statements. Although, some exemptions do exist that help streamline this process. The most common exemptions are “accredited investors” (someone classified by the SEC as a sophisticated investor), private placement offerings and limited offerings. In addition to the SEC, companies are required to register under any applicable state laws. If your company is seeking investment, then it is recommended you seek advice from a securities law attorney. A professional can assist you in navigating the complex rules and help ensure your company complies with all SEC and state regulations.

Conclusion

The outcome of the FTX scandal and future regulation on securities, including cryptocurrencies, is uncertain. However, it is fair to speculate that change is coming sooner rather than later and what comes next could be the largest regulatory step taken for securities (and cryptocurrencies for that matter) since the enactment of the Securities Act itself. FTX’s implosion should serve as a stark reminder to businesses and venture capitalists of the importance of complying with federal and state securities laws.

The information in this article does not and is not intended to constitute legal advice. All information, content, and material are for general informational or educational purposes only. The information provided may not be the most up-to-date legal information, and it is recommended that readers contact their attorney to obtain advice on any particular legal matter.