If Crypto You Will Lend, to the SEC’s Rules You Must Bend

By: Helena Alvarez

On February 14th, 2022, the Securities and Exchange Commission (“SEC”) charged BlockFi Lending LLC (“BlockFi”), a crypto lending services provider, with: (1) failing to register its crypto lending product, BlockFi Interest Accounts (“BIAs”); (2) violating the registration provisions of the Investment Company Act of 1940; and (3) violating antifraud provisions of the Securities Act of 1933.[1] The SEC and BlockFi ultimately reached a settlement, described as the first of its kind in that it involved one of the largest penalties imposed on a crypto lending platform,[2] which is essentially an online platform that allows investors to lend crypto assets in exchange for interest payments.[3] As part of the settlement, BlockFi agreed to pay a $50 million penalty, stop unregistered sales of its BIAs, and attempt to bring its business in line with the relevant Investment Company Act provisions within sixty days.[4] This settlement signals to crypto lending platforms, carrying out activities similar to BlockFi’s, that they should “seek regulatory compliance or potentially face SEC inquiries.”[5]

In his September 2021 testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, SEC Chairman Gary Gensler noted, “To the extent that there are securities on [digital asset] trading platforms, under our laws they have to register with the Commission unless they qualify for an exemption.”[6] The first charge against BlockFi supports Chairman Gensler’s position and makes clear that the SEC will continue to scrutinize interest-bearing crypto accounts, treating crypto-lending products as securities.[7] According to the SEC order, BlockFi offered and sold the BIAs to investors, which they then used to lend crypto assets to BlockFi in exchange for interest.[8] BlockFi generated the interest by lending crypto assets itself as well as by investing in equities and securities.[9] Based on this activity, the SEC not only concluded that BlockFi offered and sold the BIAs as investment contracts under SEC v. W.J. Howey Co,[10] but also that the BIAs were notes under Reves v. Ernst & Young.[11] This signifies a departure from the SEC’s single application of Howey in determining whether certain digital assets, such as initial coin offerings (“ICOs”), classify as securities.[12] Having concluded that BlockFi’s BIAs were investment contracts and notes, the SEC found that they were securities.[13] And because BlockFi offered and sold the securities without registering them and without qualifying for an exemption for registration, the SEC charged it with violating Section 5 of the Securities Act of 1933.[14]

Once a security is registered with the SEC, a company becomes subject to disclosure and reporting requirements.[15] Because the agency has taken its time defining the rules on securities registration for players in the crypto space, many have been “left continuing to guess” whether they should comply with SEC registration requirements in the first place.[16] In fact, as recently as September 2021, Chairman Gensler likened the crypto market to the “Wild West” and noted the regulatory gaps affecting it.[17] However, in recent months, the SEC has evidently tightened its grip in the crypto space by filing a number of enforcement actions against crypto exchanges.[18] Additionally, it has paid close attention to crypto lending platforms’ product offerings.[19] For example, last fall, the SEC issued a Wells Notice to Coinbase after the company announced the launch of a crypto lending product, Lend, which it eventually cancelled.[20]

The most recent action against BlockFi represents “the first case of its kind with respect to crypto lending platforms.”[21] Following the BlockFi settlement, players in the crypto space should take note of the fact that the SEC is willing to “crack down” on crypto lending platforms and that it will likely scrutinize those platforms’ product offerings under a dual application of Howey and Reves.[22] While more crypto lending platforms will likely come under scrutiny, players in the crypto space now have a unique opportunity to cooperate with the SEC and possibly clarify the applicable rules on securities registration.[23]

[1] Press Release, SEC, BlockFi Agrees to Pay $100 Million in Penalties and Pursue Registration of its Crypto Lending Product (Feb. 14, 2022), https://www.sec.gov/news/press-release/2022-26.

[2] SEC Settles Charges Against BlockFi Lending, Ropes & Gray LLP (Feb. 23, 2022), https://www.ropesgray.com/en/newsroom/alerts/2022/February/SEC-Settles-Charges-against-BlockFi-Lending#:~:text=On%20February%2014%2C%202022%2C%20in,BlockFi%20Lending%20LLC%20(BlockFi).

[3] Cryptocurrency Lending and Borrowing, cleartax, https://cleartax.in/s/cryptocurrency-lending-and-borrowing (Feb. 3, 2022, 10:13 PM).

[4] Supra note 1.

[5] David A. Lopez-Kurtz, Crypto Lending: The SEC Weighs In, Dinsmore & Shohl LLP (Feb. 18, 2022), https://www.natlawreview.com/article/crypto-lending-sec-weighs.

[6] Gary Gensler, Chairman, SEC, Testimony Before the S. Comm. on Banking, Hous. & Urb. Affs. (Sept. 14, 2021).

[7] Carol Alexis Chen, BlockFi’s Settlement with the SEC Signals Some Interest-Bearing Crypto Accounts Will Be Viewed as Securities, Winston & Strawn LLP (Feb. 25, 2022), https://www.winston.com/en/crypto-law-corner/blockfis-settlement-with-the-sec-signals-some-interest-bearing-crypto-accounts-will-be-viewed-as-securities.html?utm_source=Mondaq&utm_medium=syndication&utm_campaign=LinkedIn-integration.

[8] See In the Matter of BlockFi Lending LLC, Securities Act Release No. 11029, Investment Company Act Release No. 34503, 2022 WL 462445 (Feb. 14, 2022).

[9] Id.

[10] See 328 U.S. 293, 301 (1946) (explaining that an investment contract exists when “the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.”).

[11] See 494 U.S. 56, 66 (1990) (providing that a note classifies as a security when: (1) “the seller’s purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate;” (2) there is “common trading for speculation or investment;” (3) there is a public expectation that the note is a security; and (4) no other regulatory scheme significantly reduces the risk of the note).

[12] Framework for “Investment Contract” Analysis of Digital Assets, SEC, https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets (last visited Mar. 4, 2022).

[13] See In the Matter of BlockFi Lending LLC.

[14] 15 U.S.C. § 77e.

[15] Registration Under the Securities Act of 1933, Investor.gov, https://www.investor.gov/introduction-investing/investing-basics/glossary/registration-under-securities-act-1933 (last visited Mar. 4, 2022).

[16] Sheelah Kolhatkar, The Challenges of Regulating Cryptocurrency, The New Yorker (Oct. 6, 2021), https://www.newyorker.com/business/currency/the-challenges-of-regulating-cryptocurrency.

[17] Gary Gensler, Chairman, SEC, Testimony Before the S. Comm. on Banking, Hous. & Urb. Affs. (Sept. 14, 2021).

[18] See e.g., In the Matter of Poloniex, LLC, Exchange Act Release No. 93050, 2021 WL 4242629 (Sept. 17, 2021).

[19] See Eric Mills et al., 2021 Brought SEC Focus on Crypto Exchanges and Lending Platforms, McGuire Woods LLP (Jan. 10, 2022), https://www.consumerfinsights.com/2022/01/2021-brought-sec-focus-on-crypto-exchanges-and-lending-platforms/ (highlighting that “the SEC is shifting its attention to crypto exchanges and lending products . . .”).

[20] Nate DiCamillo, Coinbase Drops Planned ‘Lend’ Program After SEC Warning, CoinDesk (Sept. 20, 2021, 12:01 PM), https://www.coindesk.com/markets/2021/09/20/coinbase-drops-planned-lend-program-after-sec-warning.

[21] Hester Peirce, SEC Brings First Case Against Crypto Lending Platform, Markets Media (Feb. 15, 2022), https://www.marketsmedia.com/sec-brings-first-case-against-crypto-lending-platform/.

[22] Deborah R. Meshulam & Mark F. Radcliffe, SEC Settles with BlockFi Crypto Lending Platform, DLA Piper (Feb. 18, 2022), https://www.dlapiper.com/en/us/insights/publications/2022/02/sec-settles-with-blockfi/.

[23] See Adam C. Pollet et al., SEC’s Latest Shot at the Crypto Industry: BlockFi Sanctioned for its Unregistered Crypto-Lending Product, Eversheds Sutherland LLP (Feb. 16, 2022), https://www.californiaconsumerprivacy.com/mobile/NewsCommentary/Legal-Alerts/248620/SECs-latest-shot-at-the-crypto-industry-BlockFi-sanctioned-for-its-unregistered-crypto-lending-product (suggesting that players in the crypto space could cooperate with the SEC by “potentially registering more crypto assets to avoid negative scrutiny.”).