The Securities and Exchange Commission (the “SEC”) and Bitqyck, Inc. and its founders, Bruce E. Bise and Samuel J. Mendez (collectively the “Defendants”) reached a $10.1 million dollar settlement following allegations that the Defendants violated various securities laws in selling investors unregistered digital tokens. (Andrew Ramonas, Bloomberg Law).  The SEC’s complaint alleged the Defendants violated the antifraud provisions and the registration requirements of the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”) and also separately violated the Exchange Act in running an unregistered securities exchange. (SEC Complaint). The settlement resulted in Bitqyck agreeing to pay disgorgement, prejudgment interest, and a civil penalty amounting to approximately $8.4 million, with Bise and Mendez individually paying approximately $890,000 and $850,000, respectively. (Andrew Ramonas, Bloomberg Law). As part of the settlement agreement, Defendants neither admitted nor denied wrongdoing in response to the SEC’s allegations. (Id.).

According to the complaint filed by the SEC, Bitqyck raised more than $13 million from over 13,000 investors by mass marketing and selling two digital tokens—Bitqy and BitqyM—to prospective investors in multiple states and countries through several, fraudulent unregistered offerings. (SEC Complaint). Additionally, the complaint alleges that the Defendants made many material misrepresentations and omissions to investors and engaged in deceptive conduct concerning the unregistered digital token offerings. (Id.). Such misrepresentations included statements that every investor would automatically receive Bitqyck common stock, statements about the existence of a global marketplace for Bitqy tokens called “QyckDeals,” and false claims that Bitqyck owned a cryptocurrency mining facility in Washington state. (Id.). Finally, the complaint alleges that Bitqyck created and ran its own online trading platform, TradeBQ.com, which Bitqyck was required to register with the SEC as a national securities exchange. (Id.).

By engaging in the conduct mentioned above, the SEC asserted five distinct charges against some or all of the Defendants. (Id.). First, the complaint alleges that each Defendant violated 10b-5 of the Exchange Act. (Id.). Section 10(b) encompasses the anti-fraud provisions of the Exchange Act. In order to be in breach of Section 10b-5 of the Exchange Act, Defendants must have,

“directly or indirectly, singly or in concert, by the use of the means or instrumentalities of interstate commerce and/or by use of the mails, in connection with the purchase or sale of securities: (a) employed devices, schemes, and artifices to defraud; and/or (b) made untrue statements of a material fact and omitted to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and/or (c) engaged in acts, practices, and courses of business which operate or would operate as a fraud and deceit upon purchasers, prospective purchasers, and any other persons (emphasis added).” (Id.).

Second, the complaint claims the Defendants violated Section 17(a) of the Securities Act, which constitutes the anti-fraud provisions. (Id.). The standard for fraud under the Securities Act is almost identical to the standard iterated above for the Exchange Act.  The main difference is that fraud under the Securities Act applies to the “offer or sale” of securities instead of the “purchase and sale” of securities. (Id.). Therefore, the SEC can prosecute a defendant for fraud if any offering of securities was made regardless of whether the defendant actually sold them or an investor purchased them. 

Third, the SEC’s complaint alleges the Defendants violated Sections 5(a) and 5(c) of the Securities Act. (Id.). These sections constitute the registration requirements for securities under the Securities Act. A defendant would violate these provisions by using methods of “interstate commerce” to offer or sell unregistered securities. (Id.).

Fourth, the SEC charged Bitqyck individually for operating an unregistered national securities exchange in violation of Section 5 of the Exchange Act. (Id.). If Bitqyck used “any means or instrumentality of interstate commerce for the purpose of using a facility of an exchange within or subject to the jurisdiction of the United States to effect one or more transactions in a security,” it could be held liable for hosting an unregistered exchange. (Id.). The SEC’s final, and fifth, charge was against Bise and Mendez for assisting their company, Bitqyck, in running the unregistered exchange. (Id.). The complaint alleges that they “knowingly or recklessly provided substantial assistance to Bitqyck in its violations of Section 5 of the Exchange Act.” (Id.).

Assuming the allegations contained in the SEC’s complaint are true, the Defendants would have likely faced significant liability under both the Securities Act and the Exchange Act for failing to register securities, fraudulently offering or selling securities, running or assisting in running an unregistered national securities exchange, or any combination of the aforementioned charges.  However, many of these charges hinge on Bitqyck’s digital tokens being deemed a security.  SEC registration requirements and regulations apply only if the digital tokens meet the definition of a security. (SEC). Because the parties reached a settlement and, as part of such arrangement, the Defendants did not admit or deny culpability, it is uncertain what exact liability the Defendants may have faced. (Andrew Ramonas, Bloomberg Law).  This action, however, may highlight a growing concern the SEC has for digital tokens and their sale to investors. 

Regarding these types of investments, David Peavler, the Director of the SEC’s Fort Worth Regional Office, commented “because digital investment assets represent a new and exciting technology, they can be very alluring, especially if investors believe they are getting in on the ground floor.” (Id.). The concern of the SEC seems to be focused on those taking advantage of the fad of investing in digital tokens, and the lack of awareness and regulation surrounding this type of investment because of its novelty.

It is likely too soon to tell if this action represents a coming SEC crackdown on digital tokens and their offerings. However, the SEC’s recently published guidance does caution that this type of offering “bring[s] increased risk of fraud and manipulation because the markets for these assets are less regulated than traditional capital markets.” (SEC). This SEC guidance, published in April 2019, seeks to provide “plain English” advice to would-be issuers as to when digital tokens qualify as securities and would thus fall under the purview of the SEC. (Nikhilesh De, Coindesk).

Although SEC guidance is not legally binding, the published guidance made it clear that the SEC would be applying the familiar Howey Test established in the 1946 Supreme Court case, SEC v. W.J. Howey Co. (Nikhilesh De, Coindesk). The Howey Test is comprised of several factors the SEC uses to determine if something is considered a security, however, in the case of digital tokens and cryptocurrency, the primary considerations are “whether or not cryptocurrency investors are participating in a speculative enterprise, and if so, if the profits those investors are hoping for are primarily dependent upon the work of a third party.” (Jake Frankenfield, Investopedia).

Based on the Bitqyck complaint, it seems likely that the Defendant’s potential fraudulent and misleading claims to investors were egregious enough to be targeted by the SEC, irrespective of the fact that digital tokens were involved. Therefore, this action is more likely a product of the SEC’s position when it comes to misleading or taking advantage of investors as opposed to signs of prosecution of digital tokens as investments. However, given the SEC’s expressed concern with investor susceptibility concerning digital tokens, moving forward, it will be interesting to observe how the SEC treats digital tokens not being registered as securities in cases where there is no issue of intentionally misleading investors as was the case here.