BlockFi Settles With SEC and State Regulators Regarding Unregistered Crypto Lending Product | Practical Law

BlockFi Settles With SEC and State Regulators Regarding Unregistered Crypto Lending Product | Practical Law

The SEC settled charges against BlockFi Lending LLC for failing to register the offers and sales of a retail crypto lending product under the Securities Act of 1933. In a first-of-its-kind action, the SEC also charged BlockFi with violating the registration provisions of the Investment Company Act of 1940 (ICA). BlockFi settled related actions with state regulators, as well, and the SEC issued an investor bulletin on crypto asset interest-bearing accounts.

BlockFi Settles With SEC and State Regulators Regarding Unregistered Crypto Lending Product

by Practical Law Finance
Published on 16 Feb 2022USA (National/Federal)
The SEC settled charges against BlockFi Lending LLC for failing to register the offers and sales of a retail crypto lending product under the Securities Act of 1933. In a first-of-its-kind action, the SEC also charged BlockFi with violating the registration provisions of the Investment Company Act of 1940 (ICA). BlockFi settled related actions with state regulators, as well, and the SEC issued an investor bulletin on crypto asset interest-bearing accounts.
On February 14, 2022, the SEC entered a cease-and desist order under Section 8a of the Securities Act of 1933 (Securities Act) and Section 9(f) of the Investment Company Act Of 1940 (ICA) settling charges against BlockFi Lending LLC (BlockFi), a Delaware limited liability company and a wholly owned subsidiary of BlockFi Inc. (BFI), a Delaware corporation, both based in Jersey City, New Jersey, for:
  • Failing to register the offers and sales of a retail crypto lending product under the Securities Act (see Securities Act Violations).
  • Violating the registration provisions of the ICA. According to the SEC, this is its first-ever case brought against a retail crypto lending platform for violating the registration provisions of the ICA (see Investment Company Act Violations).
The SEC also issued an investor bulletin on crypto asset interest-bearing accounts (see SEC Investor Bulletin on Crypto Asset Interest-Bearing Accounts).
The SEC found that, from March 4, 2019 to the present, BlockFi offered and sold BlockFi Interest Accounts (BIAs) to investors through which investors lend crypto assets to BlockFi in exchange for BlockFi’s promise to pay a variable monthly interest payment. According to the SEC, BlockFi touted that BIA balances of up to 25 Bitcoin or 500 Ether (equivalent to approximately $100,000 and $70,000, respectively, at the time) would earn an annual percentage yield (APY) of 6.2% with all balances over that limit earning a tiered rate of 2.0% APY.
However, the SEC found that, as of November 1, 2021, the interest rates BlockFi actually paid investors ranged from 0.1% to 9.5%, depending on the type of crypto asset and the size of the investment. The SEC also found that BlockFi offered and sold BIAs as investment opportunities and misrepresented the level of risk in the BIA investment opportunity.

Securities Act Violations

The SEC found further that:

Investment Company Act Violations

The SEC also found that, from at least December 31, 2019 to at least September 30, 2021, BlockFi operated as an unregistered investment company because BlockFi was an issuer of securities engaged in the business of investing, reinvesting, owning, holding, or trading in securities and owning investment securities, as defined in Section 3(a)(2) of the ICA, having a value exceeding the ICA threshold of 40% of its total assets (exclusive of government securities and cash items). As a result, BlockFi violated Section 7(a) of the ICA by engaging in interstate commerce while failing to register as an investment company with the SEC.
The SEC found that BlockFi did not satisfy the terms of the "market intermediary" exclusion from registration under Section 3(c)(2) of the ICA because BlockFi was not primarily engaged in the business of acting as a market intermediary, its principal source of gross income was not derived from intermediary business and related activities, and it did not regularly engage in the business of entering into transactions on both sides of the market for a financial contract.
According to the SEC, BlockFi did not meet any other ICA exemptions or exclusions from the definition of an investment company or seek an SEC order declaring that it was primarily engaged in a business other than that of investing, reinvesting, owning, holding, or trading in securities or otherwise exempting it from complying with ICA provisions or the rules thereunder.

SEC Penalties and Remediation

On February 14, 2022, BFI publicly announced that it intends to register and file a Form S-1 registration statement under the Securities Act for the offer and sale of a new lending and investment product, BlockFi Yield (or any similar product), which will include the filing of an indenture and Form T-1 under the Trust Indenture Act of 1939 (15 U.S.C. § 77aaa et seq.) (TIA). BlockFi has represented to the SEC that the general structure of the BlockFi Yield investment product will be consistent with a visual flow chart included in the SEC order.
To settle the SEC’s charges under the order, BlockFi agreed to pay a $50 million penalty to the SEC, cease its unregistered offers and sales of BIAs, and attempt to bring its business within the provisions of the ICA within 60 days of the SEC order by either:
  • Filing a notification of registration pursuant to Section 8(a) of the ICA, and then within 90 days of filing such notification of registration, filing a registration statement with the SEC on the appropriate form.
  • Completing steps so that BlockFi is no longer required to be registered under Section 7(a) of the ICA and providing the SEC staff with sufficient credible evidence that it is no longer required to be registered under the ICA.

Peirce Dissenting Statement

SEC commissioner, Hester Peirce, issued a dissenting statement questioning whether the approach the SEC is taking to crypto lending is the best way to protect crypto lending customers and whether the $50 million SEC penalty protects investors. Peirce also noted that even assuming BlockFi perseveres and prevails in the S-1 registration process, before it can restart its new crypto lending program, it must leap through another "regulatory hoop" under the ICA, which may prove unsuccessful.

Settlement of Related State-Law Violations

In a separate announcement issued February 14, 2022 the North American Securities Administrators Association (NASAA) and the SEC reported that BlockFi agreed to pay a separate $50 million civil penalty to settle charges from state regulators that BlockFi failed to comply with state registration requirements and deprived investors of critical information and disclosures necessary to understand the potential risks of its crypto lending products. NASAA noted that the 32 state securities regulators that have agreed to the terms of the BlockFi settlement are expected to be joined by more state regulators.
From July 21, 2021 through August 6, 2021, five states took regulatory action to prevent BlockFi from selling unregistered digital asset securities (see Legal Update, Five States Take Regulatory Action to Prevent BlockFi From Offering Unregistered Digital Asset Securities).

SEC Investor Bulletin on Crypto Asset Interest-Bearing Accounts

On February 14, 2022, the SEC's Office of Investor Education and Advocacy (OIEA) and the SEC's Enforcement Division Retail Strategy Task Force jointly issued an investor bulletin on crypto asset interest-bearing accounts to educate investors about risks with accounts that pay interest on crypto asset deposits.
The bulletin observes that interest-bearing account for crypto asset products may sound similar to interest-bearing accounts with a bank or credit union, but investors need to be aware that these crypto asset-related accounts are not as safe as bank or credit union deposits. The OIEA bulletin uses the SEC enforcement action against BlockFi as an example of investor risks in crypto asset deposits. The bulletin notes that investors can find additional information on crypto assets at Investor.gov.