SEC Settles “First-Of-Its-Kind” Action Over “Decentralized Finance” Technology, Alleging Fraud And Unregistered Sales Of Securities
On August 6, 2021, the U.S. Securities and Exchange Commission (“SEC”) announced that it reached a $13 million settlement in a cease-and-desist proceeding against Blockchain Credit Partners (“the Company”) and its two owners. The Company marketed itself as a “decentralized finance” (“DeFi”) technology company that sold two kinds of digital assets: (1) “mTokens,” which were sold as accruing 6.2% interest, and (2) DMM Governance (“DMG”) tokens designed to give holders certain voting rights, a share of excess profits, and the ability to profit from DMG resales in the secondary market. In its cease-and-desist order (the “Order”), the SEC concluded that both mTokens and DMG tokens were securities because they were offered and sold as investment contracts, claimed that the Respondents violated Section 5(a) and 5(c) of the Securities Act for selling these securities without registering them, and further claimed that the Respondents made certain material misstatements and omissions in connection with the sale of the securities in violation of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder.
As detailed in the Order, mTokens entitled investors to collect a fixed interest rate if they deposited a certain digital asset (e.g., Ether, Dai, or USD Coin) to a smart contract. The Company represented that it would use the investors’ digital assets to purchase “real world” assets like car loans that would generate income to pay the interest rate and generate surplus profits. At any time, investors were supposed to be able to redeem their mTokens and receive the value of their initial investment plus interest. However, according to the SEC, the value of the investors’ principal—the digital asset—fluctuated wildly in value. As a result, if investors redeemed their mTokens, the Company could cover the interest but not the investors’ principal, and the SEC claimed that the Company dealt with the setback by making it appear as though the “real world” assets were profitable enough to cover any redemption by investors. According to the Order, the Company falsely represented that DMM had acquired profitable, income-generating car loans that backed up the mTokens and directed others to alter vehicle lien documents to falsely reflect DMM ownership, whereas in reality, DMM never had ownership of the car loans; the car loans were under the ownership of another company controlled by the Company’s owners.
Without admitting or denying the SEC’s allegations, Respondents agreed to pay approximately $13 million in penalties. The SEC’s settlement marks the first time that the agency has enforced an action involving sales made through DeFi technology and reflects the SEC’s interest in increasing enforcement of novel technologies used to conduct securities transactions. At the same time, the settlement is in some ways nothing new, as the allegations include claims of traditional misstatements and fraud, which just happen to have come about in the context of smart contracts that the SEC concluded were unregistered securities.