The SEC recently obtained an emergency asset freeze against several cryptocurrency funds, their respective general partners and other controlling entities. The regulator alleged that the funds’ founder, Stefan Qin, sought to misappropriate fund assets while continuing to lure new investors.

Pillsbury Corporate senior counsel Ildiko Duckor and counsel David Oliwenstein add insight in the Hedge Fund Law Report’s analysis of the complaint.

The SEC charged that, by reason of the alleged fraudulent conduct outlined above, the defendants violated the antifraud provisions of Section 17(a) of the Securities Act of 1933, as well as Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b‑5 thereunder, which make it unlawful, in connection with the offering, purchase or sale of securities, to use fraudulent schemes or devices; to make untrue statements or omissions of material fact; and to engage in fraudulent or deceptive business practices. The Complaint also alleges that the Entity Defendants “knowingly provided substantial assistance to Qin,” and to each other, in the commission of those violations. Notably, the SEC did not claim violation of the antifraud provisions of Section 206 of the Investment Advisers Act of 1940 (Advisers Act). The action certainly involves an investment adviser and affiliates under Qin’s common control, Duckor noted.

“Although several of the allegations include fraudulent disclosures to investors – a frequent claim by the SEC under Section 206 of the Advisers Act – there are claims of plain fraud here, which include deception and misuse or theft of investor funds,” she observed.

The SEC is still wrestling with the scope of the April 2019 decision of the U.S. Court of Appeals for the D.C. Circuit in Robare v. SEC, which “rejected the SEC’s longstanding position that ‘willful’ violations of the securities laws include conduct that is merely negligent,” Oliwenstein added. When the SEC “believes that it can obtain all the relief that it needs under the other anti-fraud provisions, it might be reluctant to include charges under Section 206 to avoid creating additional bad law from its perspective,” he explained. Given the agency’s need to seek emergency relief, it might also not have had sufficient time to fully vet potential claims under the Advisers Act. SEC staff can always seek authorization from the Commission to broaden their claims and amend the Complaint accordingly, he observed. 

Read the full analysis in the Hedge Fund Law Report (Paywall).