U.S. Capitol building in Washington, D.C. October 9, 2016. (Photo: Mike Scarcella/ALM)

House lawmakers took the co-directors of the Securities and Exchange Commission’s enforcement division to task Wednesday on the agency’s oversight of initial coin offerings, with Rep. Brad Sherman, D-Calif., calling on the SEC officials to “shut it all down.”

During a hearing Wednesday on oversight of the SEC, enforcement co-director Steven Peikin told the House Financial Services Committee’s Capital Markets Subcommittee that the division has leveraged its Cyber Unit to address the following areas:

  • Market manipulation schemes involving false information spread through electronic and social media;
  • Hacking to obtain material, nonpublic information and trading on that information;
  • Violations involving distributed ledger technology and initial coin offerings;
  • Misconduct perpetrated using the dark web;
  • Intrusions into online retail brokerage accounts; and
  • Cyber-related threats to trading platforms and other critical market infrastructure.

“In an effort to keep pace with technological change, we’re focusing the enforcement division’s efforts and resources on emerging cyber-related threats and issues, including issues relating to hacking, data breaches, virtual currencies and initial coin offerings,” Peikin told the lawmakers. “We think these are among the greatest risks facing investors and the financial markets today.”

But Sherman told the SEC officials that the agency hasn’t acted quickly enough to protect ICO investors.

“When somebody is trying to fund creation of jobs, they’ve got to do it very carefully or you’re on them for a misstatement in Footnote 27,” he said. “When somebody is selling cryptocurrencies to investors, it’s taken you awhile to shut them down, you’re still wondering, there’s still delay.”

Rep. Carolyn Maloney, D-N.Y., said that there was “strong debate about whether a token that is offered in an ICO can be a security when it is first issued to investors and then later evolve into something that is not a security.”

Stephanie Avakian, co-director of the enforcement division along with Peikin, responded “that’s really a question for the agency’s Division of Corporation Finance.”

That said, “it’s always going to be a facts and circumstances test as to whether something meets the definition of a security,” Avakian said. “If the substance of something changes over time, that analysis is going to have to continue to happen. But we really do look at the substance of the transaction, not the name of it.”

The SEC’s Office of Investor Education and Advocacy also released Wednesday a mock initial coin offering website, HoweyCoins.com, that mimics a coin offering to educate investors about what to look for before they invest in a scam. Those clicking on “Buy Coins Now” will be directed instead to investor education tools and tips from the SEC and other financial regulators.

Impact of Supreme Court’s Kokesh Decision

In the last fiscal year, the commission returned a record $1.07 billion to harmed investors, Peikin said.

However, despite the agency’s ability to recover funds for investors, Peikin told the lawmakers, the recent Supreme Court decision in Kokesh vs. SEC “threatens” the agency’s ability to continue to recover investor funds when it comes to “long-running frauds.”

That decision, Peikin said, held that “claims for disgorgement were subject to a five-year statute of limitations. As you would expect, many fraudsters try to conceal their schemes, some are successful and defraud investors for years before they’re discovered.”

While the agency “appreciates the need for a clear statute of limitations, we’re redoubling our efforts to uncover, investigate and bring cases as quickly as possible,” Peikin said, “but no matter how quickly we work, it’s likely that the Kokesh decision will impact our ability to obtain recovery for harmed investors in long-running frauds.”

Peikin added: “It’s a very significant decision that’s having a meaningful impact on our ability to recover funds and return them to investors, particularly cases of long-running frauds where they’re not discovered until time has passed.”

The agency has been keeping track in its “litigated and settled cases,” Peikin said, “of how much money we’ve had to forgo” because of the Kokesh decision, with the latest numbers being over $800 million in the last year. “It’s a very meaningful percentage.”

SEC ‘Soft on Wall Street?’

Rep. Bill Huizenga, R-Mich., chairman of the subcommittee, queried the co-directors on recent news reports that the agency may be “getting soft of Wall Street” with the drop in enforcement actions since the new administration — citing 754 actions brought in 2017 versus 828 in 2016.

Avakian responded that “When we think about to what degree we are protecting the retail investor, when we think about our effectiveness, we really think it’s most important to look at the nature and the quality of our actions, the actions we’re taking, and what it is we’re doing.”

While statistics, she continued, of “how many actions the commission has filed over a given period of time, or the total amount of financial remedies over a given period of time, can be some measure of activity, we don’t think that that’s the way to really look at the effectiveness of our program.”

Instead, “we take a step back and look more meaningfully at what are the actions we’re bringing, are we making a difference for investors.”

Huizenga probed further, asking: “So can [the enforcement division's effectiveness] be evaluated solely on the number of actions? What should be the evaluation? How should you be measured?”

Avakian responded: “We should be measured on are we creating deterrents against wrongdoing? Are we getting bad actors out of the marketplace? Some of these things are measureable by statistics, but many are not.”

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