Texas BitConnect Ban Tip of Spear for State ICO Regulation

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By Lydia Beyoud and Andrew Ramonas

An emergency cease-and-desist-order filed by the Texas State Securities Board against U.K.-based BitConnect is the latest sign more enforcement actions are on the way against cryptocurrencies at both the federal and state level.

The order filed Jan. 4 halting the company’s Jan. 9 initial coin offering came the same day that multiple state securities regulators advised the public to “go beyond the headlines and hype” of cryptocurrencies and fully understand the potential risks.

“The Texas State Securities Board action is consistent with the recent and heightened interest in cryptocurrency activities shown by regulators more broadly. We are likely seeing the beginning of a trend in increased scrutiny — and enforcement action — in this area by state and federal regulators,” Jai R. Massari, a partner at Davis Polk & Wardwell LLP, told Bloomberg Law.

Enforcement actions are likely to focus on ICOs, Michael Selig, at attorney with Reed Smith LLP, told Bloomberg Law. “Up until this point we’ve had civil litigation at federal courts” and some federal enforcement actions, but states haven’t been very active in enforcement of cryptocurrencies outside the realm of money transmission, Selig said.

States Sound the Alarm

That could all be about to change as securities regulators across the country sent up warning shots Jan. 4 to investors and companies.

The order in Texas came hours after an organization representing state securities agencies cautioned investors looking into cryptocurrency investments. The statement from the North American Securities Administrators Association quickly attracted bipartisan praise from Securities and Exchange Commission members.

NASAA found that 94 percent of state and Canadian provincial securities regulators fear a “high risk of fraud” concerning cryptocurrencies. The regulators also agreed that more cryptocurrency regulation is needed to ensure investor protection, according to NASAA.

“Yesterday’s action by state securities regulators in Texas is representative of the strong enforcement role of NASAA members and is reflective of increased regulatory scrutiny of cryptocurrency-related investment products,” Bob Webster, a spokesman for the organization, told Bloomberg Law.

The Texas securities regulator alleged BitConnect was engaged in multiple activities that violated Texas securities laws, constituted fraud, or misled investors. The company failed to register with the state to sell securities, and likewise failed to register the agents it recruited to sell its products, according to the order.On its website, BitConnect promises investors up to 120 percent annual returns on their investments. The ICO proposed to accept bitcoins, currently valued at approximately $16,000 per coin, in exchange for BitConnect coins. The company values its market cap at $4.1 billion based on the value of all BitConnect Coins currently issued.BitConnect didn’t immediately respond to a request for comment.

Long Arm of the Law?

While some in the cryptocurrency trading community have long viewed BitConnect as a potential Ponzi scheme, the company has an active and avid fan base. Texas-based users who try to work around the ban on the company could open themselves to potential legal issues, Selig said.

“The order said BitConnect Coins are securities. Persons that own them and are trading them have to comply with the state securities laws as well,” Selig said. For example, BitConnect Coin users who try to reroute their internet protocol (IP) addresses to avoid looking like ones registered in Texas could be violating securities laws. However, it’s unclear how the state might handle that situation, and the bulk of securities law compliance falls on BitConnect to prevent Texans from accessing its platform, Selig said.

While the force of the order stops at Texas’ borders, its symbolism is further-reaching. “The SEC is unlikely to say these aren’t securities” and overturn the order, Selig said.

Tokens offered through an ICO that relate to precious metals or energy could also come under scrutiny by other state-based regulators, Selig said.

Exchanges that list BitConnect Coins may begin also delisting or halt trading for U.S.-based users, Selig said. “The exchanges would be silly not to consider the implications of state law persuading the SEC to consider these to be securities as well,” he said.

To contact the reporters on this story: Lydia Beyoud in Washington at lbeyoud@bloomberglaw.com; Andrew Ramonas in Washington at aramonas@bloomberglaw.com

To contact the editor responsible for this story: Michael Ferullo at mferullo@bloomberglaw.com

For More Information

Text of the order is at http://src.bna.com/vrP.

Text of the news release is at http://src.bna.com/vrQ.

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