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After Bitcoin surges, Texas regulators start to scrutinize virtual currency offers

In recent weeks, the Texas State Securities Commissioner issued the country’s first state-level orders against firms offering cryptocurrency-based investments.

Posted January 10th, 2018

The skyrocketing value of Bitcoin and the launch of several new virtual currencies in recent months has attracted a wave of new investors and speculators. 

It has also attracted the eye of federal and state securities regulators across the country. 

The Texas State Securities Board ratcheted the scrutiny up a notch in recent weeks, as it has issued the country’s first state-level orders against firms allegedly offering cryptocurrency-related investments in the state. 

In the orders, State Securities Commissioner Travis Iles said the two overseas companies, USI-Tech and BitConnect, offered investments that require registration with the board prior to sale. Both firms can appeal the rulings. 

The growing attention from regulators stems largely from the huge runup in the value of Bitcoin over the past half year. Back in May, Bitcoins were worth about $2,000 apiece. By mid-December, their value had grown almost tenfold, peaking at $19,343 each on Dec. 16, according to Coindesk. 

The soaring value piqued the interest of a wider range of investors, and it set off a wave of offers by startups hoping to hop on the opportunity, said Joe Rotunda, director of the Texas securities board’s enforcement division. 

“The tipping point is seeing investments no longer limited to hobbyists or enthusiasts, but reaching Main Street investors,” Rotunda said. 

The prospect of more regulatory oversight does not sit well with many enthusiasts, who see virtual currencies as a decentralized, more efficient and freer way of exchanging value. Its key strength, many argue, is the lack of government regulation and centralized control. 

Still, many proponents have welcomed previous crackdowns on fraudulent offerings, saying they worry a few bad actors could prompt an overreaction by regulators or policy makers. 

For their part, securities regulators admit they do not regulate currencies. Rather, they’re keeping an eye out for offerings that go beyond the mere introduction of a new currency and begin to look like traditional securities like stocks or bonds. 

In those cases, regulators say, companies need to follow securities regulations, which require that companies target only wealthier investors or disclose far more information about the company, its operations and its risks. 

“Investors are entitled to receive sufficient information to make a reasonable decision about whether to purchase an investment,” Rotunda said. 

One reason this has gotten so murky is the emergence of more “initial coin offerings,” in which companies raise money by selling virtual coins or tokens. 

These might be used solely as a currency — a way to exchange value from one party to another. But in some cases, companies are enticing investors with the possibility of additional returns the company would generate and pay back to coin investors. 

At that point, regulators say, the companies are selling a security, not merely introducing a new currency. Under securities regulations, companies must register their offerings and provide enough information for investors to make a reasonable judgment about the risk involved. (Some exceptions exist for investments peddled privately to wealthier investors.) 

Absent that information, regulators contend, fraudulent actors might too easily fleece Main Street investors – especially in the environment of greater anonymity that surrounds many virtual currencies. In December, the North American Securities Administrators Association called initial coin offerings one of the emerging investor threats for 2018. 

Jay Clayton, chairman of the U.S. Securities and Exchange Commission, agreed. 

As coin offerings currently operate, “there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation,” Clayton said in a Dec. 11 statement. 

Clayton noted that merely calling an offering a “utility token” or coin doesn’t define it as a currency. While the form might change with the emergence of virtual currencies, he argued, the substance of most of the coin offerings to date has resembled traditional securities offerings.

Yet, efforts to steer clear of securities regulations aren’t simply a matter of privacy, anti-regulatory sentiment or anonymity, said Prabhudev Konana, an information management professor at the University of Texas McCombs School of Business.

“The process in which a company can raise money is complex, time-consuming and expensive,” Konana said. “It’s an expensive proposition for a startup. … So how can I bypass the whole thing? They found a channel they could use to bypass the regulatory constraints.” 

That’s a vital side of the pendulum that swings back-and-forth between financial innovation and regulation in the United States, he said. China shut down coin offerings entirely. Here, entrepreneurs will push the boundaries to see where they go, and regulators will respond to ensure new practices don’t unduly jeopardize markets or investors. 

Both Konana and Andrew Whinston, director of the McCombs’ Center for Research in Electronic Commerce, said the SEC eventually will have to provide more clarity on regulation of coin offerings. 

Until then, two things will continue to happen. Investors will take risks, and companies rolling out coin offerings will try reach a broad audience without triggering the expensive and complex securities regulation process. 

It’s buyer beware, Whinston said, but then so were the days of the dot-com bubble or so many other hot investment trends. 

“The world has always welcomed speculation,” he said, “going back thousands of years.”

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