SEC Alerts Investors: Of Bitcoin Risks

by Manatt, Phelps & Phillips, LLP
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For the second time in less than one year, the Securities and Exchange Commission (SEC) has issued an alert to investors about the risks of investing in Bitcoin and other virtual currency-related opportunities.

“A new product, technology, or innovation – such as Bitcoin – has the potential to give rise to both frauds and high-risk investment opportunities,” the SEC wrote. “Potential investors can be easily enticed with the promise of high returns in a new investment space and also may be less skeptical when assessing something novel, new and cutting-edge.”

This Investor Alert follows an earlier SEC warning about the risks of Bitcoin in the context of Ponzi scams and a recent FINRA release cautioning investors about the risks.

The latest Alert reviews the risks that may be associated with Bitcoin investment opportunities and potential warning signs of investment fraud.

Another concern is the vulnerability of Bitcoin users, those who made money from the rapid increase in the price of Bitcoin. The SEC noted that “many early adopters of Bitcoin may have experienced an unexpected increase in wealth, making them attractive targets for fraudsters as well as promoters of high-risk investment opportunities.” It pointed out that “scam artists may take advantage of Bitcoin users’ vested interest in the success of Bitcoin to lure these users into Bitcoin-related investment schemes,” some of which may be legitimate but high-risk. It cautioned that fraudsters and promoters alike might solicit users “through forums and online sites frequented by members of the Bitcoin community.”

Investors should be aware of red flags signaling investment fraud – such as unlicensed sellers and unsolicited offers. The SEC also warns that using Bitcoin could limit the user’s chance of recovery if fraud or theft should occur because the party involved is unregulated or operating unlawfully. Law enforcement in particular may face challenges when investigating the illicit use of virtual currency, including the difficulty in tracing the flow of money, the international scope of transactions, the lack of a central authority overseeing Bitcoin and the difficulty in seizing assets.

The agency provided a list of unique risks posed by Bitcoin investments, including the lack of federal deposit or securities-related insurance, the historical volatility of prices, the threat that federal, state or foreign governments may restrict or prohibit the use of virtual currencies, technology-related security concerns and the lack of a proven track record of credibility and trust.

“Innovations and new technologies are often used by fraudsters to perpetuate fraudulent investment schemes,” the SEC concluded. “Bitcoin does not have an established track record of credibility and trust.”

To read the SEC’s Investor Alert, click here.

Why it matters: The SEC’s second Bitcoin Investor Alert is thoughtful and well-presented. While it singles out Bitcoin among an ever-growing class of virtual currencies, the SEC is not solely focused on it. As virtual currencies continue to experience problems with their banking relationships, it would have been useful for the SEC to note that the issues raised in the Alert are no different from those raised by a variety of types of financial instruments and that they are all vulnerable to abuse by fraudsters and promoters. Other agencies are also looking at Bitcoin. The Federal Election Commission approved Bitcoin for political contributions, albeit capped at $100. The Federal Reserve discussed the potential disruptive impact of crypto and other virtual currencies at its most recent Open Market Committee meeting, and the Conference of State Bank Supervisors convened the first in an expected series of hearings on how to regulate them.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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