Crypto Industry Eyes SEC’s ‘Regulation by Enforcement’ Ramp Up

Regulation by enforcement will continue in the absence of concrete crypto legal frameworks, according to industry executives and lawyers, as regulators are seeking to spotlight recent investor protection issues in the space. 

Crypto-related cases and enforcement actions have picked up in recent weeks. The SEC most recently charged 11 people for allegedly creating and promoting a fraudulent crypto pyramid and Ponzi scheme, called Forsage, that raised more than $300 million from retail investors.

The regulator, along with the US Department of Justice (DOJ) also charged a former Coinbase employee, along with his brother and his friend, with insider trading last month. The SEC alleges in the complaint that nine different crypto tokens are securities.

On June 30, the DOJ charged six people with crypto fraud offenses in cases involving more than $100 million in losses. One was the largest known NFT scheme charged to date, involving an alleged so-called “rug pull” scheme involving the Baller Ape Club NFTs.  

Much of the latest enforcement activity has been in the works for a while, according to Ari Redbord, head of government affairs at TRM Labs.  

“These aren’t necessarily new frauds or scams; they’re frauds or scams that are now finding their way through the enforcement system or the criminal justice system,” he said. “It feels very much like a lot is going on right now, but some of it is the culmination of what started six months or a year ago.” 

Regulation by enforcement on a backdrop of regulatory uncertainty

The SEC renamed its cyber team in the agency’s Division of Enforcement to the Crypto Assets and Cyber Unit, in May. The regulator revealed at the time that it would add 20 people to the team responsible for protecting investors in crypto markets and cyber-related threats, bringing its headcount to 50.

“The SEC has already turned up the heat, and I would expect that heat to continue and possibly get even hotter as the SEC attempts to expand its authority over an industry already inundated with regulatory uncertainty,” said Adam Pollet, a partner in Eversheds Sutherland’s securities enforcement and litigation practices.

Patrick Daugherty, a former SEC lawyer and partner at Foley & Lardner, added: “Fraud cases are easy cases. I expect the SEC to bring easy cases to chalk up easy wins.”

The Department of Justice in February named a director for its National Cryptocurrency Enforcement Team — a new unit focused on digital asset seizure and blockchain-based lawbreaking.

Redbord, who, before TRM Labs, was a US prosecutor and an official at both the DOJ and the US Department of the Treasury, said that recent events such as the collapse of Terra’s algorithmic stablecoin UST and the LUNA token have spurred regulators to want to shine a light on consumer protection issues and stability risk in the space.

“It’s difficult to get anything through Congress, so you’re not necessarily going to get any clear legal framework any time soon,” he added.

“You see regulation by enforcement action for better or worse because without clear legal frameworks, regulators are going to sort of interpret their own authorities themselves.”

Though guidelines are fairly clear in the anti-money laundering space, having a clear regulatory framework in place is critical in the securities space, Redbord said. 

Unlike the DOJ, which must prove wire fraud, he added, the SEC must also show that the co-conspirators traded on insider information involving securities.

Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., in June introduced the Responsible Financial Innovation Act, which has a section on “securities innovation.”

“That is something that is going to be negotiated and iterated on and discussed for some time,” he said. 

What’s next in the Forsage case?

Though industry watchers expect the SEC to ramp up enforcement actions within the crypto space, they acknowledged not all cases will be easy. 

Forsage, for example, continued to operate despite receiving cease-and-desist actions from the SEC of the Philippines in September 2020 and the Montana Commissioner of Securities and Insurance in March 2021.

The alleged scheme’s website, which was operating at the time the charges were filed, now appears to be shut down. 

Founders of Forsage were last known to be living in Russia, the Republic of Georgia and Indonesia. Pollet said the defendants may challenge the jurisdiction of the SEC, to the extent that they surface at all.

The SEC can ask the court to enter a temporary restraining order or an asset freeze against operators of an alleged fraudulent scheme to prevent further dissipation of investor funds while the litigation proceeds, he added. But it does not appear the regulator has done so, Pollet said, noting that it could be because the relevant assets reside outside the US.

An SEC spokesperson declined to comment beyond the complaint.

Redbord said getting Forsage co-founders Mikail Sergeev and Sergey Maslakov— last known to be living in Russia — into a US courtroom would be especially difficult.

Sergeev, along with another defendant in the SEC case, Lola Ferrari, moved on to a new and similarly suspect project, dubbed Express Smart Game, while another Forsage creator, Vladimir “Lado” Okhotnikov, funneled traffic from the Forsage YouTube channel to his new (alleged) scam, Meta Force, the complaint notes.

“It becomes something of a sort of name and shame,” Redbord said, “where you want to ensure that these individuals — and Forsage in particular — are known out there as entities not to do business with.”

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