The Securities and Exchange Commission has launched a massive crackdown on alleged fraud in the cryptocurrency business that could result in dozens of enforcement actions against companies and individuals in the next year over the sale and promotion of this burgeoning and under-regulated industry, FOX Business has learned.
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The SEC crackdown largely focuses on so-called initial coin offerings, or ICOs, in which startups raise capital through the sale of cryptocurrencies, and accept payment from investors in the form of other cryptocurrencies such as bitcoin.
The benefit of an initial coin offering is that it can escape the costs of regulation – these startups are essentially doing an initial public offering without major compliance costs including having to register on an exchange.
But it’s exactly this lack of transparency that has drawn scrutiny from the SEC, where Chairman Jay Clayton has made cracking down on abuse in the cryptocurrency business his top priority since being sworn in as Wall Street’s top cop in May of last year.
Since taking office, Clayton’s enforcement staff at the SEC has brought as many as nine cases involving cryptocurrency fraud, but people at the commission and securities lawyers familiar with the agency’s enforcement agenda said investigators are working on dozens more. Those cases have been trickling out in recent months, but according to securities lawyers a deluge of enforcement actions is expected sometime this year, given the immense caseload under scrutiny.
The people who know Clayton’s thinking said he likens much of the hype involving cryptocurrencies to other manias that have cost small investors sometimes their life savings, such as the Dutch financial bubble of the seventeenth century, known as the “Tulip Mania,” or some of the excesses found at the end of the internet bubble during the late 1990s and early in 2000.
“I would say the day of reckoning is coming in this area,” said Harvey Pitt, founder of the consulting firm Kalorama Partners and chairman of the SEC under President George W. Bush. “And I think it reflects the deep-seated concern that some of the activity going on requires enforcement action that must be taken to prevent investors from being preyed upon.”
An SEC spokesman had no comment but would not deny the agency’s intense interest in the matter.
The focus on initial coin offerings and how so-called retail investors may be harmed reflects Clayton’s view that such under-regulated methods of raising cash are ripe for abuse particularly when they target less sophisticated, small investors, according to people with direct knowledge of his thinking.
Because these offerings can elide normal regulatory checks typical in a listing on a stock exchange, they can easily be havens for fraudsters selling hyped products or technologies that don’t work –much as boiler rooms sold shares of fraudulent companies through cold-calling methods during the 1990s.
Despite the lack of regulation, the SEC can still mount enforcement actions because cryptocurrencies are regarded as securities that are regulated by the commission.
Given the public’s interest in cryptocurrencies, ICOs have been booming; in 2017, more than $6 billion of such offers were sold, and this year sales could match last year’s levels even as the mania surrounding bitcoin has diminished and its price is well off its highs from the beginning of the year.
Most worrisome for the SEC is that much of the growth of cryptocurrencies involves small investors buying and trading these securities, and many small investors may have given into the hype as bitcoin reached its high of nearly $20,000 late last year. Bitcoin has sold off recently and is currently valued at a little less than $7,000.
Clayton, who was nominated by President Donald Trump to run the commission in January 2017, has taken some heat for a decline in enforcement actions under his watch. Critics claim Clayton is following the Republican agenda to reverse the regulatory crackdown on businesses and Wall Street that began under President Barack Obama.
But people who know Clayton said he is refocusing the commission’s regulatory agenda on issues that most affect small investors, rather than violations such as insider trading, or the trading of material, nonpublic information among professional traders.
With that focus, the SEC’s enforcement activities will scrutinize practices in which small investors could be the targets of fraud. Clayton believes that given the hype surrounding bitcoin and the cryptocurrency business as a whole, retail investors are particularly vulnerable to potential illegality.
“Obviously, there are some real businesses involved in cryptos,” said a securities lawyer who represents targets of the SEC’s probe. “But Clayton believes much of it is one big fraud.”
The SEC concerns over fraud in the cryptocurrency business have delayed, possibly indefinitely, the approval of a bitcoin exchange-traded fund, which would track the price of bitcoin in dollars or the price of futures contracts tied to the cryptocurrency. The ETF would be sold to small investors, which has many inside the regulatory community concerned over the suitability of less-sophisticated buyers delving into such an obtuse market.
Tyler and Cameron Winklevoss, the twins who gained celebrity status for wrangling with Mark Zuckerberg over the creation of Facebook, have reapplied with the SEC for a bitcoin ETF after their initial bid was rejected by the commission last year.
People close to the SEC said the Winklevosses face an uphill battle persuading the SEC to approve the ETF given Clayton’s concerns about fraud in this business. A spokeswoman for the Winklevosses had no immediate comment.