There must have been a palpable air of professional envy when prosecutors at the SEC drew straws back in September to determine who would make up the newly formed Cyber Unit. Established to police the anarchic young cryptocurrency economy, team members could rest assured they wouldn't get bogged down in years-long investigations that peter out in unsatisfying legal dead-ends. No, thanks to the mania and naïveté that pervades the realm of initial coin offerings, prosecutors on the Cyber Unit could be confident they'd soon be chalking up regulatory Ws.
Now the Cyber Unit has made its first sting. Clearly they didn't have to exert themselves:
The Securities and Exchange Commission today announced it obtained an emergency asset freeze to halt a fast-moving ICO fraud that raised up to $15 million from thousands of investors since August by falsely promising a 13-fold profit in less than a month.
The action, announced late Friday, comes against “recidivist Quebec securities law violator” Dominic Lacroix and his company PlexCorps, which created and marketed a crypto asset called PlexCoins. Says the SEC, it was all a “full-fledged cyber scam.”
And scammy it was. PlexCoin's public statements boasted what we now know was a fictional office “at the heart of Singapore” and a team of 40-plus unnamed tech professionals around the world – who happened not to exist. On its website, PlexCoin said it was withholding its employees' identities “to make sure no one is getting harassed on social media or recruited by other cryptocurrency companies, thus preventing the concept of PlexCorps from being copied.” Conveniently, “recidivist” Lacroix's involvement was also kept secret. Red flag.
PlexCoin also promised ludicrous rewards. Investors in the first round of token offerings would “enjoy a return of 1,354% on your investment!” Investors in later rounds were guaranteed returns of 629%, 332%, or 200% within the first month of trading, after which “the value should normally increase,” as any good asset does. To assuage any doubts, PlexCoin's white paper noted that “the numbers might seem enormous, but they are real.” Another red flag.
These warnings signs didn't go unnoticed by experienced ICO investors. PlexCoin ICO is a Scamcoin read one post. Another found plagiarized materials in PlexCoin's white paper. Quebec's securities regulator even issued a cease-and-desist a few weeks before the ICO.
Despite all this, Lacroix and his associates managed to raise what the SEC believes to be around $15 million. This is despite being kicked off of multiple payment platforms, PayPal included, and the entire project being an obvious swindle.
So congrats to the SEC's Cyber Unit on what might be the easiest financial regulatory case of the year. But what does it mean for the rest of the ICO world?
Crypto entrepreneurs are currently caught in a bind. They want to attract capital by selling tokens, but in a way that doesn't scream SECURITIES OFFERING. At present, that means lots of verbal contortions about what exactly is being sold (utility tokens, not profit-making investments) and to whom (end-users, not investors). The big unknown is whether the SEC will accept token-sellers' story that they're just selling what amounts to company gift cards, not investments that carry a reasonable expectation of profits.
In that regard, the PlexCoin case presents a phenomenally low bar. The SEC characterizes the whole thing as a transparent scam, and the two top charges against Lacroix are for straight-up fraud (an accomplice is also named). But the third charge is over failing to register with authorities before offering a security. It's this charge that legit ICOs fear.
In analyzing whether something is a security, “form should be disregarded for substance,” Tcherepnin v. Knight, 389 U.S. 332, 336 (1967), “and the emphasis should be on economic realities underlying a transaction, and not on the name appended thereto.”
The economic realities in the ICO space right now are this: Entrepreneurs need to raise cash to finance their lofty ambitions, while crypto-hungry investors are flooding into the crypto space and pissing themselves over the promise of stupid profits. For someone with even a passing familiarity with the context of ICO world, it would be loopy to say that profits aren't expected. And that's a problem. Says the SEC:
The “touchstone” of an investment contract “is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”
PlexCoin might not be the ideal test-case for the above, but it shows that not only are the feds concerned with fraud, but with the offering of unregistered securities. That touches every ICO, not just ones based in the heart of Singapore promising guaranteed 13-fold returns.
In the short run, though, the PlexCoin action is bullish for ICOs, which can now claim to inhabit a federally regulated, scam-free space. And to a degree, this is fair; the existence of penny-stock pump-and-dumps doesn't invalidate the entire equities market. But the news was bearish for at least one asset: FIZZ.