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Enforcement News: SEC Charges Film Producer, Rapper, and Others for Promoting Allegedly Fraudulent Initial Coin Offerings

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  • Posted on: Sep 16 2020

The term “digital asset” or “digital token” generally refers to an asset that is issued and transferred using distributed ledger or blockchain technology, including “cryptocurrencies,” “coins,” and “tokens.” A blockchain or distributed ledger is a peer-to-peer database spread across a network, that records all transactions in theoretically unchangeable, digitally recorded data packages. The system relies on cryptographic techniques for secure recording of transactions. Blockchains or distributed ledgers can also record “smart contracts,” essentially computer programs designed to execute the terms of a contract when certain triggering conditions are met. Entities have offered and sold digital assets in fundraising events, called “initial coin offerings” or “ICOs,” in exchange for consideration, often other digital assets. 

Generally, digital assets may entitle holders to certain rights related to a venture underlying the ICO, such as rights to profits, shares of assets, rights to use certain services provided by the issuer, and/or voting rights. These digital tokens may also be listed on online digital asset trading platforms, where they can be traded for other digital assets or fiat currency. The digital tokens are often transferable immediately upon delivery to investors.

ICOs are typically announced and promoted through public online channels. The prospectus soliciting the public to acquire tokens in the ICO is usually in the form of a “white paper,” which constitutes marketing materials describing the project and the terms of the ICO. To participate, investors may transfer funds to a unique digital address set up by the issuer, and the issuer may deliver tokens to the participants’ unique digital address on a distributed ledger or blockchain. This process may be partially automated through the use of a smart contract.

On July 25, 2017, the Securities and Exchange Commission (“SEC”) issued the DAO Report of Investigation (the “Report”) (here), advising that digital tokens or coins may be securities, and thus, subject to the federal securities laws. In particular, the Report found that tokens offered and sold by the “virtual” decentralized, autonomous organization known as “The DAO” were securities and therefore subject to the federal securities laws. The Report confirmed that issuers of distributed ledger or blockchain technology-based securities had to register offers and sales of such securities unless a valid exemption applied. The Report made clear that those participating in unregistered offerings could also be liable for violations of the securities laws. Additionally, securities exchanges providing for trading in these securities had to register unless they were exempt. 

The Report stemmed from an inquiry that the SEC’s Enforcement Division launched into whether The DAO and associated entities and individuals violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for “Ether,” a virtual currency. 

On September 11, 2020, the SEC announced (here) that it brought charges against five Atlanta-based individuals, including film producer Ryan Felton, Clifford Harris, Jr., a well-known musician, actor, and producer, also known as T.I. or Tip, and three others who each promoted one of Felton’s two unregistered and allegedly fraudulent ICOs. The SEC also charged FLiK and CoinSpark, the two unincorporated Atlanta-based companies controlled by Felton that conducted the ICOs. Aside from Felton, all the individuals agreed to settle the charges against them.

In the complaint (here), the SEC alleged that Felton promised to build a digital streaming platform for FLiK and a digital-asset trading platform for CoinSpark. Instead, Felton allegedly misappropriated the funds raised in the ICOs. The SEC also alleged that Felton secretly transferred FLiK tokens to himself and sold them into the market, reaping an additional $2.2 million in profits, and that he engaged in manipulative trading to inflate the price of SPARK tokens.  Felton allegedly used the funds he misappropriated and the proceeds of his manipulative trading to buy a Ferrari, a million-dollar home, diamond jewelry, and other luxury goods.

In a settled administrative order (here), the SEC found that Harris offered and sold FLiK tokens on his social media accounts, falsely claiming to be a FLiK co-owner and encouraging his followers to invest in the FLiK ICO. Harris also asked a celebrity friend to promote the FLiK ICO on social media and provided the language for posts, referring to FLiK as T.I.’s “new venture.” The SEC’s complaint alleged that T.I.’s social media manager William Sparks, Jr. offered and sold FLiK tokens on T.I.’s social media accounts, and that two other Atlanta residents, Chance White and Owen Smith, promoted SPARK tokens without disclosing they were promised compensation in return.

“The federal securities laws provide the same protections to investors in digital asset securities as they do to investors in more traditional forms of securities,” said Carolyn M. Welshhans, Associate Director in the Division of Enforcement. “As alleged in the SEC’s complaint, Felton victimized investors through material misrepresentations, misappropriation of their funds, and manipulative trading.”

The SEC filed its complaint in the U.S. District Court for the Northern District of Georgia. The SEC charged Felton with violating registration, antifraud, and anti-manipulation provisions of the federal securities laws.  FLiK and CoinSpark were charged with violating registration and anti-fraud provisions. White and Smith were charged with violating registration and anti-touting provisions. Sparks was charged with violating registration provisions. The SEC seeks injunctive relief, disgorgement of ill-gotten gains, and civil monetary penalties, as well as an officer-and-director bar against Felton. 

In the settled order, Sparks agreed to disgorge his ill-gotten gains plus prejudgment interest. Sparks, White, and Smith each agreed to pay a penalty of $25,000 and to conduct-based injunctions prohibiting them from participating in the issuance, purchase, offer, or sale of any digital asset security for a period of five years. Harris agreed to pay a $75,000 penalty and not participate in offerings or sales of digital-asset securities for at least five years. The proposed settlements are subject to court approval. 

Three of Felton’s family members and an LLC that he established were also named as relief defendants. 

The U.S. Attorney’s Office for the Northern District of Georgia brought criminal charges against Felton in a parallel action (here). In that proceeding, the government is seeking a forfeiture of the proceeds of Felton’s alleged schemes.

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