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Cryptocurrency ruling provides regulatory guidance

Posted On: Feb. 26, 2019 7:00 AM CST


A federal court ruling in which the U.S. Securities and Exchange Commission was granted a preliminary injunction against an initial coin offerings company provides ICO firms some guidance on how to proceed without incurring regulatory scrutiny.

This in turn could ultimately lead to insurers’ greater willingness to offer coverage for cryptocurrencies, observers say.

In his Feb. 14 ruling, U.S. District Judge Gonzalo P. Curiel in San Diego reversed an earlier ruling and granted the SEC a preliminary injunction against Los Angeles-based Blockvest LLC in Securities and Exchange Commission v. Blockvest LLC and Reginald Buddy Ringgold III a/k/a Rasool Abdul Rahim El.

The complaint alleged the defendants were offering and selling unregistered securities in the form of digital assets called BLVs that involved an initial coin offering, said the ruling.

The SEC complaint said Blockvest and Mr. Ringgold falsely claimed their ICO had been registered and approved by the SEC and used the agency’s seal on the company’s website.

In ruling in the SEC’s favor, the judge said the agency “has presented a prima facie showing” of fraud under federal securities law, which “creates an inference that defendants will likely violate the securities law in the future if not enjoined.”

An SEC spokeswoman had no comment beyond the release issued on the ruling, while a Blockvest spokesman could not be reached.

“You really can’t overstate the significance of any court’s ruling” on cryptocurrency because there is so much hype surrounding it, with every ruling “looked at under a microscope,” said John Reed Stark of Bethesda, Maryland-based John Reed Stark Consulting LLC, who is a former chief of the SEC’s Office of Internet Enforcement.

Cryptocurrency is “being promoted as a means of financing that’s fast and easy, and boards need to be concerned, when they do that sort of thing, whether or not their insurance company would cover any liability issues for anything related to this space,” said Mr. Stark, who believes ICOs should be considered securities.

However, insurers have generally been unwilling to insure cryptocurrency-related issues. David Zaslowsky, a partner with Baker & McKenzie LLP in New York, said, “I think much of the concern of the SEC is the amount of fraud that has been happening with these companies, and so much of the money that’s disappeared. I think insurance companies would be reluctant to underwrite these companies because very few of them have track records.”

American International Group Inc., like most insurers in financial lines, is taking a cautious approach, said David Murray, New York-based financial lines head of product innovation for AIG, who spoke during a cryptocurrency session at the Professional Liability Underwriting Society’s 2019 Directors & Officers Symposium in New York in February.

“Our appetite for this risk continues to be limited, and largely that’s a reflection of regulatory uncertainty,” which is the biggest challenge, he said. Another factor is that this area is “at a very early stage” and lacks a claims history, he said.

“You have a market that is being more conservative with the capital that they’re able to deploy. There’s no reason for a carrier to feel like it has to go into the ICO space,” said Rob Yellen, New York-based executive vice president of Willis Towers Watson PLC’s FINEX North America practice.

The Blockvest ruling is a positive development because it provides clarity and a consistent framework for ICOs to follow, said Mr. Yellen.

The ruling is “kind of a roadmap of what companies should not do when they’re marketing their ICOs,” said William D. Carson, an associate with Clyde & Co US LLP in Washington.

A major insurer concern is “the ICO process right now is a little bit like the Wild West, and there’s a lot of Silicon Valley in the way it is marketed,” he said. “This particular case is a good example of what not to do,” he said, adding the firm’s offering made statements “that were just flat out not true,” citing the SEC’s claims.

Mr. Carson said, “It’s hard to effectively price the product because we don’t really know what the risks involved are,” so it is difficult for insurers to perform due diligence.

“But once more cases and more SEC actions are instituted and resolved, the opacity of that issue is going to clarify, and if the price is right, and people are willing to buy it at a price that makes sense, of course the carriers will offer the coverage,” Mr. Carson said.

Jacob Decker, Seattle-based vice president and director of financial institutions for Woodruff Sawyer, said, “The carriers are still very cautious” about offering coverage for ICO firms’ regulatory exposures because “they’re looking for best in class. They’re looking for experienced management teams who, from a culture perspective,” are trying to do the right thing, he said.

They are also looking for those who “want to engage regulators proactively, that are setting up governance and internal controls,” and following the approach of more traditional companies that offer equity or shares to the public, he said.

There have been some D&O policies issued in connection with ICOs, but “it’s not broad-based. It is very risk-specific, so if we can position a client as truly being first in class,” having the right management team and the right approach “and doing all those things that give the carrier comfort, there are carriers wiling to have those conversations and willing to provide meaningful coverage,” he said.

Sarah Downey, Marsh LLC’s co-leader of its digital asset risk transfer team in New York, said once there is clear guidance from the SEC as to what is and is not a security, underwriters’ positions will change. With more certainty, “the insurance market will be so much more comfortable in offering the coverage,” she said.

Ms. Downey said right now, while it is difficult, some clients have obtained insurance for digital assets offerings. “Coverage is not impossible to get. It’s just difficult to get right now,” she said.