SEC Charges ‘Defi’ Lender, Governance Token Issuers Should Take Notice
The US Securities and Exchange Commission (SEC) charged Cayman Islands-registered DeFi Money Market (DMM) and its top executives, two Florida men, for unregistered sales of more than USD 30m of securities using smart contracts and “so-called “decentralized finance” (DeFi) technology.”
DMM has already been closed down due to “regulatory inquiries,” per their website.
The SEC claims that, from February 2020 to February 2021, Gregory Keough and Derek Acree were selling mTokens that paid 6.25% interest, and DMG “governance tokens” that purportedly gave holders certain voting rights, a share of excess profits, and the ability to profit from DMG governance token resales in the secondary market.
According to the SEC, the mTokens were notes and were also offered and sold as investment contracts, the DMG governance tokens were offered and sold as investment contracts.
Respondents consented to a cease-and-desist order that includes disgorgement totaling almost USD 13m and penalties of USD 125,000 each for Keough and Acree, the Commission added.
Per the SEC, this is how they operated:
- The respondents stated that DeFi Money Market could pay the interest and profits because it would use investor assets to buy “real world” assets that generated income, like car loans.
- The respondents realized that DeFi Money Market could not operate as promised because the price volatility of the digital assets used to purchase the tokens created risk that the income generated through income-generating assets would be insufficient to cover appreciation of investors’ principal.
- Rather than notifying investors of this roadblock, the respondents misrepresented how the company was operating, including by falsely claiming that DeFi Money Market had bought car loans that they displayed on DeFi Money Market’s website.
- While the respondents controlled another company that owned car loans, DeFi Money Market never acquired an ownership interest in any of those loans.
- Instead, the order finds that the respondents used personal funds and funds from the other company they controlled to make principal and interest payments for mToken redemptions.
According to Gabriel Shapiro, attorney at law firm Belcher, Smolen & Van Loo, he’s “pretty sure this is the first SEC action holding ‘governance tokens’ per se to be securities.”
He stressed that the SEC is going to argue that APYs (annual percentage yields) and annual percentage rates (APRs) are “promises” and “every single DeFi front-end would do well to adjust how it is talking about them & add in-your-face disclaimers and nuance.”
“For most DeFi folks, one big lesson I’ve been trying to stress for years is that you can’t just create a company somewhere else but stay in US to avoid application of our law,” Collins Belton, the managing partner of the legal firm Brookwood, added, noting that while DMM is just “masquerading as DeFi” this case is still relevant to the industry.
According to the lawyer, in this case, there are many lessons “about things like having a controlled foreign company, [governance tokens] potentially being securities, and fraudulent advertising.”
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