Venture capital firms that have invested in crypto exchanges are coming into the crosshairs of the Securities & Exchange Commission as the government regulator continues its crackdown against anything it considers to be an unregistered security.
While the SEC regulates the securities markets and works to protect investors from fraud, the government has yet to provide clarity on how digital assets such as cryptocurrencies are treated under U.S. securities law.
Congress wants to regulate crypto and SEC Chairman Gary Gensler had said several times that he plans to take a more rigorous approach. The major question appears to be whether crypto is a security or commodity, wrote William Powers, a congressional ethics and political law partner at Nossaman LLP.
The SEC is expected to ask crypto-focused venture capital firms for information as it investigates whether U.S. crypto exchanges broke securities laws by improperly listing digital tokens, securities lawyers told The Information. The most prolific investors such as Andreessen Horowitz and Paradigm, are most likely to get requests for information from the SEC, lawyers said. Both VC firms invested in Coinbase, which is being investigated by the SEC for listing unregistered securities.
If crypto is a security, then crypto companies issuing tokens must comply with SEC rules for registration and reporting, Powers wrote. Failure to do so can lead to penalties such as the $100 million SEC fine issued to BlockFi in 2021.
However, many in the industry believe that crypto acts more like commodities than securities and should be treated as such, subject to the rules of the Commodity Futures Trading Commission.
Worst-case scenario, SEC investigations could drag venture capital firms into SEC enforcement actions if the SEC finds they have violated a rule, said Perrie Weiner, chair of law firm Baker McKenzie’s North America securities litigation group. “I haven’t seen yet any [venture capitalists] being formally named in enforcement action, but that’s not to say that it couldn’t happen under the right set of circumstances.”
After the last big crypto collapse, the SEC in 2018 cracked down on ICOs or unregistered initial coin offerings made by crypto startups that raised capital by selling tokens publicly to help fund their operations. Most startups abandoned ICOs after the crackdown. Now the SEC is looking at crypto exchanges that list tokens it considers to be unregistered securities, The Information reported.
Venture firms have asked SEC to issue formal guidance about which digital assets it considers securities, as opposed to making statements through enforcement actions.
“In the absence of more formal guidance from U.S. regulators or legislative action, the legal contours of this space and the claims that are being asserted in this space will be defined by case law and by the decisions that come out of both SEC enforcement actions and private plaintiff lawsuits,” said Alexander Drylewski, who is representing Coinbase and Paradigm in lawsuits.
SEC Chairman Gensler has promised tougher policing of the cryptosphere, which he likens to the “Wild West”. In August 2021, he promised to come down hard on the unregulated crypto platforms. “We just don’t have enough investor protection in crypto,” Gensler said in a prepared statement to the Aspen Security Forum. “We have taken and will continue to take our authorities as far as they go.”