<img src="https://secure.glue1lazy.com/215876.png" style="display:none;">

BlockFi Reaches a $100 Million Settlement With the SEC and Ceases Sales of its Lending Product

On February 14, 2022, the Securities and Exchange Commission (SEC) announced that BlockFi Lending LLC has reached a settlement with it and has agreed to pay a $100 million penalty for selling its crypto-lending product without registering it with the SEC. BlockFi is a financial services company that offers its users crypto wallets, trading, and crypto-backed loans.

The SEC launched an investigation into BlockFi’s practices when state regulators from Alabama, Kentucky, New Jersey, Texas, and Vermont issued either show-cause orders or cease and desist orders against the company for issuing unregistered securities.

Though this settlement is SEC’s first enforcement action targeting a crypto lending platform, it is not the first time that the SEC has exercised its regulatory scrutiny over crypto lending products. In September 2021, owing to the pressure from the SEC, crypto exchange Coinbase discontinued its plan to launch its lending product. The SEC issued a notice stating that since Coinbase’s lending product involved interest-bearing securities, it must be regulated as an investment contract and should be subjected to SEC’s oversight and registration requirements. On December 2, 2021, in his remarks before the Investor Advisory Committee, SEC Chairman Gary Gensler urged crypto platforms to register with SEC. He further clarified that those crypto lending platforms, which issue securities will fall under the regulatory ambit of the SEC and will have to register with it.

Per the SEC’s official press release, Gensler said that BlockFi’s settlement "makes clear that crypto markets must comply with time-tested securities laws." He added that the agreement with BlockFi showed "the commission’s willingness to work with crypto platforms to determine how they can come into compliance with those laws.

What happened?

According to the SEC’s settlement order, from March 4, 2019, to February 14, 2022, BlockFi offered and sold BlockFi Interest Accounts (BIAs) to its users. BIAs allowed users to lend out their crypto assets to BlockFi in exchange for the company’s promise to provide a variable monthly interest payment. The SEC explained that BlAs were essentially investment contracts, in which customers lent their money with the promise they would be repaid more at a later time. 

In addition to SEC v. W.J. Howey Co, the settlement order mentioned case laws discussed in the DAOs investigation report to lay down the criterion for an investment contract — “an investment contract is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.” The SEC alleged that through its public statements, BlockFi had created a reasonable expectation that BIA investors would earn profits in form of interest, which would, in turn, be derived from BlockFi’s efforts to manage the loaned crypto assets.

Under Section 3(a)(10) of the Exchange Act, security includes an investment contract. Since BIAs were securities under the applicable securities law, BlockFi was required to register offers and sales of BIAs but it failed to do so or to qualify for an exemption from SEC registration.

In the settlement order, the SEC also alleged that BlockFi had made a material misrepresentation to BIA investors concerning the level of risk in its loan portfolio. The order contends that, by misrepresenting the level of collateralization, BlockFi made it seem that depositing crypto with the company was safer than it really was.

Beginning at the time of the BIA launch on March 4, 2019, and continuing to August 31, 2021, BlockFi published multiple posts on its website stating that BlockFi’s institutional loans were “typically” over-collateralized, when in fact, most institutional loans were not overcollateralized. In fact, in 2020, only 16% of the total institutional crypto asset loans were overcollateralized and in 2021 approximately 17% were over-collateralized. Therefore, the posts published on BlockFi’s website materially overstated the degree to which it secured protection from defaults by institutional borrowers through collateral.

Additionally, the settlement order concluded that BlockFi operated for more than 18 months as an unregistered investment company because it issued securities and also held more than 40%  of its total assets, excluding cash, in investment securities, including loans of crypto assets to institutional borrowers.

BlockFi agreed to pay the SEC $50 million to settle the charges, without admitting or denying wrongdoing or liability. It will also pay a further $50 million to 32 states over similar charges Additionally, BlockFi has also agreed to cease offering or selling BIAs in the United States. BlockFi has also promised that it will attempt to bring its business within the provisions of the Investment Company Act 1940 within 60 days.

BlockFi to put compliance first

BlockFi released a statement regarding the SEC probe, settlement order, and the future of the company. BlockFi stated that as part of the settlement order, it intends to file or confidentially submit a registration statement on Form S-1 with the SEC for the offering of BlockFi Yield (BY), which is anticipated to be the first SEC-registered crypto interest-bearing security. SEC Form S-1 is a registration that companies must file with the SEC before they can issue publicly traded securities. BlockFi also assured its existing BIA clients that will be able to maintain their accounts and receive interest as they always have; however, they will not be able to add new assets to their accounts from February 14, 2022, onward.

It remains to be seen how BlockFi will become compliant with the SEC’s regulation and register its new crypto-lending product in a way that will satisfy the agency’s rules. Going forward, crypto lending platforms and crypto businesses will need to put compliance first and proactively engage with the SEC and other regulatory authorities to understand how they can operate within the regulatory parameter.

Gurbir S. Grewal, Director of SEC’a Division of Enforcement, urged crypto lending platforms to take immediate notice of the SEC’s resolution with BlockFi and take proactive steps to become compliant with the federal securities laws. He reminded crypto lender platforms that “adherence to our (the SEC’s) registration and disclosure requirements is critical to providing investors with the information and transparency they need to make well-informed investment decisions in the crypto asset space."

Why Merkle Science

The SEC is increasing its regulatory scrutiny over the crypto market and strictly enforcing registration requirements. Therefore, crypto-asset trading platforms looking to stay compliant should directly reach out to the regulators and seek their assistance in meeting the registration requirements. 

To avoid the pitfalls of a slow registration process, the crypto trading platforms should act as if they are already registered and put in place robust compliance frameworks that will help them in mitigating regulatory risks and meeting anti-money laundering standards set up by the regulators - giving them a clear competitive advantage.

Merkle Science’s highly customizable and easy-to-use platform provides businesses with 360-degree compliance support. Our predictive cryptocurrency risk and intelligence platform set the standard for the next generation of financial safeguards and criminal detection. Merkle Science proprietary Behavioral Rule Engine allows users to tailor the tool according to businesses’ own risk policies —based on the requirements set by each jurisdiction.