Crypto Industry Eyes SEC’s ‘Regulation by Enforcement’ Ramps Up

Regulation by enforcement will continue in the absence of concrete legal crypto frameworks, according to industry leaders and lawyers, as regulators seek to shine a spotlight on recent investor protection concerns in the space.

Crypto-related cases and enforcement actions have picked up in recent weeks. The SEC most recently charged 11 people with allegedly creating and promoting a fraudulent crypto pyramid and Ponzi scheme, called Forsage, that raised more than $300 million from private investors.

The regulator, along with the US Department of Justice (DOJ), also charged a former Coinbase employee, along with his brother and friend, with insider trading last month. The SEC claims in the complaint that nine different crypto-tokens are securities.

On June 30, the DOJ charged six people with criminal charges for crypto fraud in cases involving more than $100 million in losses. One was the largest known NFT scheme charged to date and involved an alleged so-called “rug pull” scheme involving Baller Ape Club NFTs.

Much of the latest enforcement activity has been in the works for some time, according to Ari Redbord, head of government affairs at TRM Labs.

“These aren’t necessarily new scams or scams; they’re scams or scams that are now finding their way through the enforcement system or the criminal justice system,” he said. “It feels very much like a lot is happening right now, but some of it is the culmination of what started six months or a year ago.”

Regulation by enforcement against a backdrop of regulatory uncertainty

The SEC renamed the cyber team in the agency’s Division of Enforcement to the Crypto Assets and Cyber ​​Unit in May. The regulator revealed at the time that it would add 20 people to the team responsible for protecting investors in crypto markets and cyber-related threats, bringing the number of employees to 50.

“The SEC has already turned up the heat, and I expect that heat to continue and possibly get even hotter as the SEC tries to expand its authority over an industry already awash in regulatory uncertainty,” said Adam Pollet, a partner at Eversheds Sutherlands. securities enforcement and litigation practice.

Patrick Daugherty, a former SEC attorney and partner at Foley & Lardner, added: “Fraud cases are simple cases. I expect the SEC to come up with easy cases to find easy wins.”

The Justice Department in February named a director for its National Cryptocurrency Enforcement Team — a new unit focused on seizing digital assets and blockchain-based crime.

Redbord, who before TRM Labs was a U.S. attorney and official at both the DOJ and the U.S. Treasury Department, said recent events such as the collapse of Terra’s algorithmic stablecoin UST and the LUNA token have spurred regulators to want to shed light on consumer protection issues and stability risks in the space.

“It’s hard to get anything through Congress, so you’re not necessarily going to get a clear legal framework right away,” he added.

“You see regulation by enforcement measures for better or for worse because without a clear legal framework, regulators are going to interpret their own authorities themselves.”

Although the guidelines are quite clear in the area of ​​combating money laundering, it is crucial to have a clear regulatory framework in place in the area of ​​securities, said Redbord.

Unlike the DOJ, which must prove wire fraud, he added, the SEC must also show that co-conspirators acted on inside information involving securities.

Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, DN.Y., in June introduced the Responsible Financial Innovation Act, which has a section on “securities innovation.”

“This is something that is going to be negotiated and iterated and debated for some time,” he said.

What’s next in the Forsage case?

Although industry watchers expect the SEC to increase enforcement actions in the crypto space, they acknowledged that not all cases will be straightforward.

For example, Forsage continued to operate despite receiving cease-and-desist actions from the SEC in the Philippines in September 2020 and the Montana Commissioner of Securities and Insurance in March 2021.

The alleged scheme’s website, which was operating when the charges were brought, now appears to be closed.

The founders of Forsage were last known to live in Russia, the Republic of Georgia and Indonesia. Pollet said the defendants can challenge the jurisdiction of the SEC, to the extent that they appear at all.

The SEC could ask the court to enter a temporary restraining order or an asset freeze against operators of an allegedly fraudulent scheme to prevent further waste of investor funds while the litigation continues, he added. But the regulator does not appear to have done so, Pollet said, noting that it may be because the relevant assets are located outside the United States.

A spokesperson for the SEC declined to comment beyond the complaint.

Redbord said it would be particularly difficult to get Forsage co-founders Mikail Sergeev and Sergey Maslakov – last known to live in Russia – into a US courtroom.

Sergeev, along with another defendant in the SEC case, Lola Ferrari, moved on to a new and similarly suspicious project, called Express Smart Game, while another Forsage creator, Vladimir “Lado” Okhotnikov, directed traffic from the Forsage YouTube channel to its new (alleged) scam, Meta Force, the complaint states.

“It becomes something of a name-and-shame kind of thing,” Redbord said, “where you want to make sure these people — and Forsage in particular — are known out there as entities not to do business with.”

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