Texas Judge Issues Preliminary Injunction Against Dubai-Based Officer of Allegedly Fraudulent Cryptocurrency Offering

Earlier this year, the United States District Court for the Northern District of Texas entered an ex parte temporary restraining order (TRO) against AriseBank and its top executives – Jared Rice Sr., the bank’s CEO, and Stanley Ford, the bank’s chief operating officer.  The TRO was based on the U.S. Security and Exchange Commission’s (SEC) January 2018 complaint against the trio for their allegedly fraudulent initial coin offering (ICO) of AriseBank’s blockchain-based cryptocurrency, AriseCoin.

On March 9, 2018, AriseBank and Rice agreed to entry of a preliminary injunction that included many provisions of the TRO, including the freezing of their assets.  Ford, however, who resides in Dubai, had not responded to emails from the SEC’s attorneys and had not made an appearance in the case.  Arguing that Ford is a flight risk and armed with additional evidence of Ford’s participation in the alleged fraud, the SEC moved the Court to extend the TRO as to Ford and reset his preliminary injunction hearing so that the Court-appointed receiver for AriseBank could testify as to the new evidence concerning Ford’s involvement.  The Court granted the motion, setting Ford’s preliminary injunction hearing for March 19, 2018 and extending the TRO against Ford through the hearing date.

Yesterday, the Court entered a preliminary injunction against Ford, who still has not made an appearance in the case.  Among other things, the injunction freeze’s Ford’s assets and requires him to surrender his passport and not travel outside the United States until further court order.  The Court also granted the SEC’s motion to effect service of the summons and complaint on Ford via email to Ford’s personal Gmail address and by mail to a Dubai P.O. Box associated with Ford and AriseBank.

The SEC’s Complaint Regarding the AriseCoin ICO 

The SEC alleges several problems with the AriseCoin ICO.  First, it claims AriseBank, Rice and Ford violated securities laws because the ICO is an unregistered securities offering and AriseBank had filed no Form D claiming an exemption from registration.  The SEC argues the AriseCoin ICO is a securities offering because it meets the Supreme Court’s Howey test for an “investment contract.”  Specifically, the SEC alleges: (1) the ICO requires investors to pay money to purchase AriseCoins; (2) the investment is in a “common enterprise” because the investors’ return is dependent on the efforts of AriseBank, Rice and Ford to grow the value of AriseCoins; and (3) the investors’ role in the investment program is entirely passive and their expectation of profit is based solely on AriseBank’s, Rice’s and Ford’s “entrepreneurial or managerial” efforts.  See SEC v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946).  In other words, the SEC alleges that the $600 million AriseBank claims to have raised for AriseCoin – and the $1 billion it intends to raise – are being obtained illegally.

And according to the SEC, the problems do not stop there.  The agency alleges the AriseCoin ICO’s white paper as well as AriseBank’s press releases and other public statements made in connection with the offering contained “false and misleading statements and omissions.”  As examples, the SEC’s complaint cites:

• AriseBank’s allegedly false announcement on January 18 that it had purchased an FDIC-insured bank and therefore could “offer its customers FDIC-insured accounts and transactions.”  According to the SEC, the FDIC has no record of AriseBank or that the bank it acquired is, in fact, federally insured.
• AriseBank’s claimed partnerships with a major credit card company and with payment processing platform Marqeta Inc., which the bank’s white paper allegedly claimed will permit it to create a branded card that would make “crypto in your Arise account … instantly available on your AriseCard.”  The SEC claims these statements were false. According to the lawsuit, Marqeta itself sent AriseBank a cease-and-desist letter and posted on Twitter that the claimed partnership never existed.
• AriseBank’s failure to disclose the alleged criminal histories of Rice and AriseBank President Kelvin Spencer in the executive biographies provided on AriseBank’s website and in its white papers.  The SEC alleges “[t]his information – which bears directly on the honesty and professional competence of AriseBank’s principals – would have been highly material to investors.”

Based on these allegations, the SEC’s complaint alleges several violations of securities laws and seeks permanent injunctions against AriseBank, Rice and Ford prohibiting them from further violations, and further prohibiting Rice and Ford from offering digital securities.  The complaint also seeks an order disgorging any ill-gotten gains the defendants obtained as a result of the alleged securities violations, and requiring each Defendant to pay a civil penalty.

The case is Securities and Exchange Commission v. AriseBank et al., No. 3:18-cv-00186, in the U.S. District Court for the Northern District of Texas.

Recent SEC Enforcement Action – Is This A Security?

The suit against AriseBank is one of a recent flurry of cryptocurrency-related enforcement actions, coinciding with increased warnings from federal regulators about fraud and other risks associated with cryptocurrency investments and ICOs.  These actions continue to center on the underlying question or whether a particular ICO is a security offering that must be registered with the SEC.  Adding to the lack of clarity are the many different flavors of ICOs and coins – or “tokens” – that they offer.

Certain coins serve simply as stores of value (think: Bitcoin) and function as independent monetary bases.  As SEC Chairman Jay Clayton noted at a February 6, 2018 Senate Banking Committee hearing on virtual currencies, neither the SEC nor the Commodity Futures Trading Commission (CFTC) “have direct jurisdiction over the popular markets that trade true cryptocurrencies.”  Other coins, known as “securities tokens,” entitle the holder to ownership rights in external, tradable assets such as precious metals or real estate.  A subset of securities tokens are “equity tokens,” which entitle the owner to stock in a company.  As their name implies, securities tokens likely will always be viewed as subject to federal securities registration requirements.

On the other hand, “utility tokens” provide a utility function to their holders, such as access to a product or service, and often serve as the exclusive currency for consummating transactions within the issuer’s service network.  For example, access to and payment for online cloud storage might be accomplished solely through tokens issued by the cloud storage provider.  While the value of utility tokens can fluctuate based on supply and demand, they serve more as a coupon for admission rather than ownership in a security, which may put them outside the SEC’s jurisdiction.  In his December 2017 Statement on Cryptocurrencies and ICOs, SEC Chairman Clayton acknowledged that certain utility tokens “may not implicate our securities laws,” and gave as an example a hypothetical token used to bootstrap a book-of-the-month club.  However, Chairman Clayton was quick to caution that:

Merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.  Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law.

Given Chairman Clayton’s conclusion that “[b]y and large, the structures of [ICOs] that I have seen promoted involve the offer and sale of securities,” investors and coin issuers should be on the lookout for additional guidance on the features of ICOs and tokens that the SEC will view as implicating federal registration requirements.

Be sure to check back in with the Kilpatrick Townsend Fintech blog for key market, legal, and regulatory updates on cryptocurrencies and ICOs.