The Securities and Exchange Commission’s (“SEC”) enforcement agenda for the 2022 fiscal year addresses an expansive range of financial industries and products. (Thomas Zaccaro, et al.; Bloomberg Law). Amid the rapid growth of digital assets, the SEC’s enforcement agenda includes increased focus on the scrutiny and regulation of crypto-lending, the process where an investor will deposit cryptocurrencies into a crypto-lending account and earn interest on that deposit in the form of cryptocurrencies. (Id.; Brian Breheny, et al.; Skadden; Joe Light, The Washington Post). However, it was not until a recent SEC enforcement action against BlockFi Lending LLC (“BlockFi”) that the SEC applied the Investment Company Act of 1940 (the “Act”) to a crypto-lending company, which gave the SEC the opportunity to establish its approach for regulating crypto-lending. (Robert Kim, Bloomberg Law).

The Act protects investors by regulating the organization and activities of investment companies by requiring the company to register as an investment company. (James Chen, Investopedia; SEC). The Act requires that investment companies disclose their financial condition and investment policies to investors to ensure transparency. (SEC). Under the Act, this information must be disclosed to investors when they initially purchase company stock and on a regular basis after. Id. The Act prioritizes disclosing key fund information to investors concerning financial health, risks, and structure as well as overarching investment policies, procedures, and company objectives. (Id.; SEC). Through the company registration requirement, the Act confers power to the SEC to regulate investment funds. (James Chen, Investopedia). 

In a first of its kind enforcement action, the SEC specifically applied the company registration provisions of the Act to charge BlockFi, a company providing cryptocurrency trading, lending, and borrowing services, with failing to comply with federal securities laws. (Robert Kim, Bloomberg Law; SEC). On February 14, 2022, the SEC charged BlockFi with the failure to both register its retail interest-bearing crypto-lending product and the company itself. Id.

In 2019 BlockFi began offering BlockFi Interest Accounts (“BIAs”), interest-bearing digital asset accounts. (Robin Bergen, et al., Cleary Gottlieb). BlockFi clients were given the option to store their cryptocurrency with BlockFi through BIAs and earn interest on their cryptocurrency. (BlockFi). BIAs allow customers to loan crypto assets to BlockFi in exchange for a variable monthly interest payment based on the BlockFi’s yield interest income generated from pooled BIA crypto-assets. Id. Individual BIA accounts pay depositors a variable interest rate of up to 7.5%, a rate substantially higher than that paid out by conventional bank accounts. (Robert Kim, Bloomberg Law). The annual percentage yield varies depending upon the type and amount of cryptocurrency chosen to be deposited by the client. (BlockFi). 

The SEC found BIAs to be securities under the Securities Act of 1933 because BIAs lent crypto assets to BlockFi in exchange for the BlockFi’s promise to provide a variable monthly interest payment. (SEC). As securities, BlockFi was then required to either register its BIAs as securities or find an exemption from SEC registration requirements. Id. Failing to do either, the SEC charged BlockFi with violating Section 5(a) and 5(c) of the Securities Act of 1933. (Id.; Robin Bergen, et al., Cleary Gottlieb). The enforcement order also charged BlockFi with violating Sections 17(a)(2) and 17(a)(3) of the Securities Act because the SEC found BlockFi to have made false and misleading statements of material fact for a period of over two years regarding the level of risk of its loan portfolio and lending activity on their company website. Id.

Additionally, the SEC charged BlockFi with violating Section 7(a) of the Act for failing to register itself as an investment company. Id. BlockFi met the definition of an investment company because it issued securities and engaged in “investing, reinvesting, owning, holding, or trading processes of securities worth more than 40 percent of its total assets.” Id. The SEC order found that BlockFi operated for a period of over 18 months as an unregistered investment company issuing securities in the form of its BIAs. Id. Application of the Act was unique in this case because the SEC has historically only applied the Securities Act of 1933 to crypto-lending companies. Id.

The SEC’s unprecedented order against BlockFi has become the standard for SEC regulation of unregistered crypto-lending platforms. BlockFi’s settlement indicates a strengthened and clearer approach regarding the SEC’s agenda in applying federal securities laws to emerging crypto-lending products and services. (Robert Kim, Bloomberg Law). While this SEC enforcement action resulted in $100 million of fines for BlockFi, it poses an even bigger threat to the cryptocurrency industry. Id. SEC Chair Gary Gensler described that BlockFi’s settlement establishes that crypto-lending platforms must comply with both the Securities Act of 1933 as well as the Act. Id. Analyzing crypto companies in light of both the Securities Act of 1933 and the Act gave the SEC an organized course of action to regulate the crypto industry efficiently and effectively. Compliance with both acts ensures investors are provided with the necessary information to make investment decisions within the cryptocurrency financial market. (Id.; SEC).

Although Chairman Gensler expressed willingness to work with crypto-lending platforms to ensure compliance with securities laws, the severity of the fine imposed on BlockFi indicates that the SEC is increasing regulatory oversight of the crypto-industry. (Howard Elisofon, et al., Herrick). While SEC Commissioner Hester M. Peirce stated that securities lawyers will have seen this enforcement action coming, she notes that this enforcement action will have unprecedented consequences for the crypto-lending industry. (SEC). Designation of crypto- lending products as securities initiates a new regime of costly company registration and disclosure requirements for crypto companies. (Joe Light, The Washington Post).The industry has noted that this registration and regulatory burden may be too demanding for smaller crypto companies, forcing them to withdraw their products altogether. (Id.; Ropes & Gray). 

The SEC’s enforcement action against BlockFi suggests that there will be intense focus on crypto-lending product and company registration requirements. Following the SEC’s application of the Act to crypto-lending products, it is now imperative that crypto companies are aware of the company registration requirements since there is now precedent finding crypto-lending companies are classified as investment companies. Because the SEC has not previously applied the Act to crypto-lending products, it is difficult to blame BlockFi for failing to register itself as an investment company. However, it is necessary to begin holding crypto-lending companies who issue securities and engage in investing, trading, and holding practices of securities equally accountable and to the same standard as other traditional investment companies to protect investors. 

Crypto accounts like BlockFi’s BIAs do offer greater reward than traditional bank accounts because of their higher interest rates. However, many investors fail to recognize that they are taking a substantial risk because crypto accounts are not insured by the Federal Deposit Insurance Corporation. (Joe Light, The Washington Post). It is therefore imperative to begin scrutinizing crypto-lending platforms to ensure that investors receive the same disclosures as they would with an investment in any other type of security. SEC’s new regulatory approach to the crypto industry applying the Act needed a starting point to set the standard for future regulatory action. An unprecedented enforcement action, the SEC’s order against BlockFi has become the benchmark case for SEC regulation of unregistered crypto-lending platforms.