Risk Management and Crisis Response Blog

Regulators continue cross-border crackdown on allegedly fraudulent initial coin offering

Dec 21, 2017 4 MIN READ

Québec’s Autorité des marchés financiers (AMF) and the U.S. Securities and Exchange Commission (SEC) have escalated efforts to shut down the allegedly fraudulent PlexCoin virtual currency. In early December 2017, the SEC’s new Cyber Unit obtained emergency orders to freeze assets relating to PlexCoin, and a judge of the Québec Superior Court sentenced PlexCoin’s alleged directing mind to two months in jail for failing to comply with orders by Québec’s Financial Markets Administrative Tribunal (FMAT).

These developments illustrate the close co-operation by financial sector regulators concerned about initial coin offerings. As the whereabouts of most of the $15 million allegedly received by PlexCoin remains unclear, they also demonstrate the enforcement challenges relating to ICOs and crypto-assets generally. These enforcement challenges will invariably affect crypto-currency exchanges and other Internet and financial intermediaries as regulators pursue evidence and assets relating to ICOs.

As we wrote about in August 2017, the AMF obtained orders from FMAT in July 2017 prohibiting the promotion of PlexCoin within Québec. The AMF subsequently obtained orders to freeze funds and other assets under the control of PlexCoin’s principals.

The individuals and companies behind PlexCoin apparently disregarded these orders, requiring the AMF to seek a contempt finding from the Québec Superior Court of Justice. In October 2017, a judge found Dominic Lacroix, PlexCoin’s alleged directing mind, in contempt. The judge held a sentencing hearing in November 2017, at which the AMF asked for a six month jail sentence. The judge reserved a decision, ultimately sentencing Mr. Lacroix to two months in jail and a fine of $10,000. The judge also imposed a further $100,000 fine on a corporation involved in PlexCoin. These fines were the maximum permitted by law.

Meanwhile, the AMF and SEC have apparently co-operated to advance continuing enforcement efforts against PlexCoin. In early December 2017, the SEC commenced a civil proceeding in the Eastern District of New York against PlexCoin’s principals. The SEC obtained an emergency order that, among other things, froze all assets relating to PlexCoin. PlexCoin’s principals have apparently retained U.S. counsel to respond to the SEC’s lawsuit, which will proceed with expedited document production and depositions in January and February 2018.

We return to the four key implications that we first highlighted in our August 2017 article about PlexCoin:

Regulators are highly concerned about ICOs. Canadian and U.S. securities market regulators clearly share a concern about ICOs and are working together and sharing information to enforce securities laws with respect to ICOs. Indeed, the materials filed by the SEC with the U.S. District Court included considerable evidence and orders obtained by the AMF, and the SEC acknowledged the assistance of the AMF in the SEC’s public statements on the emergency orders.

Regulators are prepared to take aggressive enforcement steps. In addition to obtaining numerous FMAT orders and conducting searches (including a search of at least one private residence), the AMF has sought and obtained a contempt judgment resulting in a two-month jail sentence. For its part, the SEC has obtained far-reaching temporary orders against PlexCoin’s principals requiring them to transfer assets relating to PlexCoin to the control of the U.S. District Court, account for value received in connection with the PlexCoin ICO and preserve and disclose relevant documents.

Enforcing securities laws against ICOs is challenging. Notwithstanding the co-operation between regulators, the case continues to illustrate the challenges of enforcing securities laws against ICOs. Despite the FMAT orders obtained by the AMF in July 2017, PlexCoin continued to operate for a further six months, apparently receiving contributions of approximately $15 million. Further, a considerable portion of the $15 million received by PlexCoin appears to be in the form of bitcoin or other crypto-currencies, which cannot be effectively frozen or seized unless the regulators obtain control of the private keys that give access to the crypto-currency. The emergency orders obtained by the SEC attempt to address this by requiring the defendants to transfer all assets relating to PlexCoin to the control of the U.S. District Court. Whether this aspect of the order will be successful in tracing and preserving these crypto-assets will undoubtedly be a critical issue as the case proceeds.

Intermediaries can expect to be affected by enforcement. The AMF’s orders have affected banks, payment processors, and a social media site. The SEC has now obtained orders against other payment processors in the U.S. As well, to obtain those orders, the SEC issued an administrative subpoena against a U.S.-based crypto-currency exchange to obtain account information. As regulators step up their enforcement activities with respect to ICOs, they will undoubtedly be seeking information from crypto-currency exchanges and enlisting exchanges to freeze crypto-assets held via exchange wallets, in addition to compelling information and assistance from more conventional financial and Internet intermediaries.