Operation CryptoSweep: Anatomy of an Alabama SEC Enforcement Action
by Albert W. Copeland II, Associate
In 2018, over 50 percent of the Alabama Security Commission’s (ASC) administrative actions target companies in the cryptocurrency space.[1] In the words of Joseph Borg, the Director of the Alabama Securities Commission, this recent flurry of enforcement actions is “just the tip of the iceberg.”[2] But why is Alabama placing such an emphasis on regulating cryptocurrency companies, and why now?
In April 2018, the North American Securities Administrators Association (NASAA), under the leadership of its President and Alabama’s own Joseph Borg, organized a task force to conduct international, coordinated investigations into Initial Coin Offerings[3] and other investment products related to cryptocurrencies in an initiative known as “Operation Cryptosweep.”[4] As of August 2018, Operation Cryptosweep resulted in more than 200 investigations, 47 of which included enforcements actions across the United States and Canada.[5]
Considering Alabama’s membership in NASAA and Borg’s position in the ASC and NASAA, it is no surprise that the state’s enforcement is likewise aggressive. The ASC is pursuing at least 21 ICO inquiries and has issued eight cease-and-desist orders since Operation Cryptosweep’s announcement in May 2018.[6] But what exactly do these cease-and-desist orders allege?
In the Matter of JINBI Limited, Andre Rafnsson and Joseph Crawly
To illustrate, consider the Commission’s recent order in September 2018: In the Matter of JINBI Limited, Andre Rafnsson and Joseph Crawly.[7] This matter, like all cease-and-desist orders filed by the Alabama Securities Commission against cryptocurrency companies this year, targets the company’s failure to register its token as a “security” under Alabama law.
First, the Order begins with general information and a brief statement of the facts about JINBI Limited, its co-founders, and the company’s ICO token sale. In short, the abbreviated version of the facts alleged are these:
- The London, UK-based company, JINBI Limited, through its co-founders Rafnsson and Crawley, operates an online entity that purports to “merge traditional gold investments with blockchain technology offering token holders a share in the profitability from the production of gold.”[8]
- In August 2018, Alabama Securities Commission discovered JINBI’s advertisement that invited Alabama residents to invest in its ICO on Montgomery’s WSFA 12 News’ website. The advertisement claimed that “JINBI allows individuals to trade gold in a peer-to-peer system to share the profitability of gold production” using JINBI tokens that could be obtained through an investment on its token site.[9]
- According to the company’s website and its whitepaper, JINBI token holders will benefit directly and share in the profitability from the production of gold through JINBI’s liquidity events following production milestones whereby each coin holder will receive a biannual dividend payable in physical gold or JINBI tokens.[10]
Upon notification of JINBI’s advertisements, the Alabama Securities Commission conducted an inquiry and found the company’s ICO efforts in Alabama to be unlawful under Ala. Code §§ 8-6-4 and 8-6-17(a)(2).[11]
In reaching its conclusion, the Commission first found that JINBI’s Initial Coin Offering qualifies as “security.”[12] Ala. Code § 8-6-2(10) defines “security,” in relevant part, to be “participation in any profit-sharing agreement … [or] investment contract.”[13] The Commission found that JINBI’s cryptocurrency plan requires “investors to invest money into the common investment plan in order to pool their investments with other investors. Investors share and expect a profit and receive biannual dividends based on investments profitability … [t]herefore, Respondents’ ICO development plans constitute investment contracts and profit-sharing agreements and are “securities” as defined by the Act.”[14]
Moreover, JINBI and its co-founders qualify as an “issuer” under Alabama securities law. Ala. Code § 8-6-2(5) defines “issuer” as “[e]very person who proposes to issue, has issued, or shall hereafter issue any security. Any person who acts for a compensation or a consideration as a promoter for or on behalf of a corporation, trust, unincorporated association, or partnership of any kind to be formed shall be deemed to be an issuer.”[15] By issuing its token sale (i.e. investment contract and/or profit-sharing agreement), JINBI, Rafnsson and Crawley are “issuers” and are subject to the Act’s provisions.[16]
Next, the Commission found that JINBI’s ICO sale to Alabama residents through WSFA 12 News’ website was in violation of Ala. Code § 8-6-4.[17] That statute provides that “[i]t is unlawful for any person to offer or sell any security in this state unless: (1) it is registered under this article; (2) the security is exempt from registration under Section 8-6-10; or (3) the transaction is exempt under Section 8-6-11.”[18] After conducting a registration file review and corporation search, the Commission found that JINBI’s investment contract and/or profit-sharing agreement “were neither registered nor subject to a perfected exception from registration in Alabama at the time of solicitation or sale and were offered in violation of the Act.”[19]
Finally, the Respondents’ failure to disclose that its JINBI tokens were “securities” in its advertisement violated Ala. Code § 8-6-17(a)(2).[20] That statute provides, in relevant part, that it is unlawful “for any person, in connection with the offer, sale, or purchase of any security, directly or indirectly … to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.”[21]
Takeaway
The JINBI matter is microcosm of the current regulatory and judicial[22] positions concerning these cryptocurrency investment products on the state and federal level. NASAA and its member states will likely continue their investigative actions to weed out possible fraudulent actors, so cryptocurrency companies that market their Initial Coin Offerings should proceed with caution to ensure they are complying with state and federal law.
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[1] Administrative Actions – 2018, Alabama Securities Commission, http://asc.alabama.gov/2018.aspx (last visited Nov. 4, 2018).
[2] Alabama Securities Commission Participates in Coordinated International Crypto Crackdown, Alabama Securities Commission, News Releases (May 21, 2018), http://asc.alabama.gov/News/2018%20News/5-21-18%20Cryptosweep%20NASAA%20-%20ASC.pdf.
[3]What to Know About ICOs, Alabama Securities Commission, Investor Alerts (May 2018), http://www.asc.state.al.us/investor_alerts.aspx (defining ICO as “a method used by an individual, group of individuals, or organization to raise capital for a planned project. Most ICOs involve projects that are at the ‘idea’ stage and in many instances may lack a prototype or ‘real world’ implementation of the idea. To finance the idea or project through an ICO, promoters create a new virtual ‘coin’ or ‘token,’ which is ten sold online to participants in the ICO in exchange for fiat currency”).
[4] Alabama Securities Commission Updates Coordinated Crypto Crackdown, Alabama Securities Commission, News Releases (August 28, 2018), http://www.asc.state.al.us/news_detail.aspx?ID=12943.
[5] Id.
[6] Id.
[7] In the Matter of: JINBI Limited, Andre Rafnsson, and Joseph Crawley, Respondents, 2018 WL 5098924, at *1.
[8] Id. at 1-2.
[9] Id.
[10]Id.
[11] Id. at 3.
[12] Id.
[13] Ala. Code § 8-6-2(10).
[14] In the Matter of: JINBI Limited, Andre Rafnsson, and Joseph Crawley, Respondents, 2018 WL 5098924, at *3.
[15] Ala. Code § 8-6-2(5)
[16] In the Matter of: JINBI Limited, Andre Rafnsson, and Joseph Crawley, Respondents, 2018 WL 5098924, at *3.
[17] Id.
[18] Ala. Code § 8-6-4
[19] In the Matter of: JINBI Limited, Andre Rafnsson, and Joseph Crawley, Respondents, 2018 WL 5098924, at *3.
[20] Id.
[21] Ala. Code § 8-6-17(a)(2)
[22] United States v. Zaslavskiy, No. 17 CR 647 (RJD), 2018 WL 4346339, at *9 (E.D.N.Y. Sept. 11, 2018) (stating that U.S. Securities law may cover initial coin offerings).