The question that seems to be at the forefront of the SEC’s crypto-regulation is whether or not the existing securities laws are appropriate for governing crypto securities; many industry participants are calling for digital asset-specific legislation.37 Roets’ SEC Response Letter states “the commission is trying to shoehorn software technology into incompatible securities law from the 1930’s. This calls into question whether the Commission understands the technology enough to effectively regulate it.”38 He closes the preamble with a quote from Thomas Paine: “Tyranny, like hell, is not easily conquered; yet we have this consolation with us, that the harder the conflict, the more glorious the triumph.”
SEC v. Dragonchain, Inc., et al. marks the 11th enforcement action involving crypto assets in 2022.39 Reports of investigations continue to circulate naming some of world’s largest crypto exchanges and entities, as the SEC stakes its claim to the crypto industry40 by means of what the Commodity Futures Trading Commission (”CFTC”) has declared “regulation by enforcement.”41 SEC Commissioner Hester Peirce also questioned the SEC’s actions in a recent tweet, stating “The SEC is a regulatory agency with an enforcement division, not an enforcement agency. Why are we leading with enforcement in crypto?”42 It is unlikely the SEC will slow down its regulatory enforcement any time soon and the power struggle of crypto jurisdiction between the SEC and CFTC will continue until legislative intervention.
Unique Factors and Firm Opinions
A key component of this case is the solicitation and profit from public funds. Section 4 of the Securities Act distinguishes between (1) the sale of securities by issuers into public markets, and (2) traditional trade transactions by investors in the market, and Section 5 requires that the public offers and sales be registered.43 According to the SEC, Dragonchain offered and sold DRGNs directly to the public; the token was offered “broadly and widely to all potential purchasers, not just those who might be reasonably expected to ‘use’ dragons.”44 The offer and sale of DRGNs was marketed using interstate commerce to promote investment, and the funds raised were pooled and used to fund the operations of Dragonchain and its technology.45
In sum, this is an isolated instance of digital assets that did not scale in a decentralized way, and will largely depend on facts related to the prior actions of organizers. This does not in any way increase the risk of enforcement action with respect to the broader crypto ecosystem, because of the unique fact pattern and the prior actions of the organizationers/related entities. Regardless of the outcome of this case, it is my opinion that most digital assets are in fact not securities. Furthermore, it is unclear if the SEC is correct and within its jurisdiction with this lawsuit, but the SEC did lay out some good arguments, which Dragonchain should work with securities counsel.
The SEC complaint demands a trial by jury, but it isn’t definite if the case will make it that far. Dragonchain revealed that during the investigation they were previously unofficially offered a settlement but declined because the SEC couldn’t provide adequate information about the outcome of the proposed settlement.46 Whether or not they will rethink their decision if a new settlement is offered in light of the formal complaint remains to be seen. Many of the accusations within the SEC complaint are directly contradicted by statements made in Dragonchain’s published response; should the case go to trial, it will be up to the jury to decide the truth.
The named defendants have not yet responded to the official complaint, but Montague Law is monitoring the case process closely and will provide an update with any future correspondence.
1E.g., MacKenzie Sigalos, Crypto Crackdown: Why federal charges over an alleged Ponzi scheme may only be the tip of the iceberg, CNBC, (Aug. 2, 2022, 7:35 AM), https://www.cnbc.com/video/2022/08/02/crypto-crackdown-why-federal-charges-over-an-alleged-ponzi-scheme-may-only-be-the-tip-of-the-iceberg.html; Sara Morrison, The Crypto Crackdown Begins, Vox (Aug. 3, 2022, 11:30 AM), https://www.vox.com/recode/2022/8/3/23290388/crypto-illegal-scams-lawsuit-sec 2About Dragonchain, https://dragonchain.com/about/ (last visited August 24, 2022) 3S.E.C. v. Dragonchain, Inc. et al., No. 2:22-cv-01145, W.D. Wa. filed August 16, 2022, https://www.sec.gov/litigation/complaints/2022/comp25468.pdf. 4Dragonchain, Fundamentals (2017), https://docs.google.com/presentation/d/10Zhvs4R7cJqUvv7Q5h1gLHr7R6i0Wo59nXGTPED3nPg/htmlpresent. The Fundamentals document provided by DC in 2017 defines the Dragon as “a tokenized micro-license (PATENT PENDING) for interaction with Dragonchain’s commercial platform services which captures legal guidance regarding US Securities law.” It also includes a disclaimer stating, “Dragon is not a financial security and should not be purchased for investment or speculative purposes. Purchasers of Dragons should have a bona fide intention to use them for interaction with the Dragonchain platform,” 5The Securities Act of 1933, as amended, 15 USCS § 77a et seq.; Section 5 of the Act mandates that any issuer of non-exempt securities to the public must register offers and sales with the Securities and Exchange Commission (SEC); the absence of such registration deems any subsequent offer and sale unlawful and subject to liability; Legal Information institute, The Securities Act of 1933, Cornell Law School, https://www.law.cornell.edu/wex/securities_act_of_1933. “The goal is to provide investors with accurate information so that they can make informed investment decisions.” 6Hybrid Blockchain Platform for Flexibility, Scalability, and Security, https://dragonchain.com/blockchain-platform(last visited August 24, 2022). 7Dragonchain™, Originally Developed at Disney, Announces October 2nd ICO to Simplify Blockchain Technology for Business Use, BusinessWire (Sep. 20, 2017, 3:00 AM), https://www.businesswire.com/news/home/20170920005471/en/Dragonchain™-Originally-Developed-Disney-Announces-October-2nd 8Id. 9Todd Bishop, SEC sues Dragonchain, alleging that $16.5M in crypto sales were illegal securities offerings,GeekWire (Aug. 16, 2022, 6:12 PM), https://www.geekwire.com/2022/sec-sues-dragonchain-alleging-that-16-5m-in-crypto-sales-were-illegal-securities-offerings/ 10Response to SEC Letter, BusinessWire (May 19, 2022), https://drive.google.com/file/d/1yipAxDM7fN3snXpwzHqj6vq0SvSseMQa/view. 11S.E.C. v. Dragonchain, Inc. et al., supra note 3. 12Beck Peterson, Disney built a blockchain, and now its creators are trying to turn it into a commercial platform to compete with Ethereum, Business Insider (Oct. 1, 2017, 8:30 AM), https://docs.google.com/presentation/d/10Zhvs4R7cJqUvv7Q5h1gLHr7R6i0Wo59nXGTPED3nPg/htmlpresent.13About The Foundation, https://dragonchain.org (last visited August 24, 2022) 14 Pink Panther, Fundamental Analysis of DragonChain (DRGN), Medium (Oct. 6, 2017), https://medium.com/@kkv54419/fundamental-analysis-of-dragonchain-drgn-1463cc971e8f 15Fundamentals, supra note 4. 16Id. 17Consent Order, State of Wash. Dep’t of Fin. Ins., Sec Div., No.: S-18-2433-21-CO01, https://dfi.wa.gov/documents/securities-orders/S-18-2433-21-CO01.pdf 18Securities Act of Washington, RCW 21.20 19Id. RCW 21.20.005. Chapter 20, Section 14 of the Securities Act of Washington defines “sale” as “Sale” or “sell” includes every contract of sale of, contract to sell, or disposition of, a security or interest in a security for value. “Offer” or “offer to sell” includes every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value. Any security given or delivered with, or as a bonus on account of, any purchase of securities or any other thing is considered to constitute part of the subject of the purchase and to have been offered and sold for value; Chapter 20, Section 17 defines security as (17)(a) “Security” means any note; stock; treasury stock; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral-trust certificate; preorganization certificate or subscription; transferable share; investment contract; investment of money or other consideration in the risk capital of a venture with the expectation of some valuable benefit to the investor where the investor does not receive the right to exercise practical and actual control over the managerial decisions of the venture; voting-trust certificate; certificate of deposit for a security; fractional undivided interest in an oil, gas, or mineral lease or in payments out of production under a lease, right, or royalty; charitable gift annuity; any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities, including any interest therein or based on the value thereof; or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency; or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any security under this subsection. This subsection applies whether or not the security is evidenced by a written document. 20Id. 21.20.140. “It is unlawful for any person to offer or sell any security in this state unless: (1) The security is registered by coordination or qualification under this chapter; (2) the security or transaction is exempted, or (3) the security is a federal covered security.” 21Id. *21.20.10. “*It is unlawful for any person, in connection with the offer, sale or purchase of any security, directly or indirectly:…
Read More:Dragonchain Sued by SEC Amidst Crypto Crackdown – Charged with Illegal Unregistered Securities Offerings | Montague Law
2022-10-06 16:23:36
