Cryptocurrency Firm BlockFi Reaches $100 Million Settlement with SEC over Cryptocurrency Lending Program

On Feb. 14, 2022, BlockFi Lending LLC (BlockFi) agreed to pay $100 million to settle state and federal regulators’ claims, including that BlockFi had failed to register its BlockFi Interest Accounts (BIAs), a cryptocurrency lending product.^[1]  BlockFi will pay a $50 million penalty to the SEC, the largest the SEC has levied against a cryptocurrency company to date, and another $50 million in fines to a group of 32 states.^[2]

In exchange for lending crypto assets to BlockFi, BIA investors received monthly interest payments.  BlockFi generated returns by re-lending investors’ crypto assets and investing in equities and futures, and investors earned interest payments that varied depending on the yield BlockFi earned from its investment efforts.  As of March 2021, BlockFi held approximately $10.4 billion in BIA investor assets and had approximately 390,000 U.S. BIA investors. 

The first of three violations the SEC asserted is that the BIAs were securities whose sale should have been registered under Section 5 of the Securities Act.  The SEC applied the Supreme Court’s Howey test — which asks whether money is invested in a common enterprise with a reasonable expectation of profits based on the managerial efforts of others — and determined that the BIAs were investment contracts, a type of security.^[3]  The Commission found that BlockFi’s statements had created a reasonable expectation that investors would profit from BlockFi’s efforts managing their pooled crypto assets.  The SEC also found that BIAs were notes, another type of security, under the Reves test because the BIAs did not bear a “family resemblance” to other non-security notes.^[4]

Next, the SEC alleged a violation of Section 17 of the Securities Act for misstatements in connection with BlockFi’s advertisement of the BIAs.  BlockFi’s website stated that its institutional loans were “typically” over-collateralized when, in fact, only between 16% and 24% were. According to the SEC, this statement was materially false because it misrepresented the risk that BlockFi would be unable to repay BIA investors if the institutional borrowers defaulted. 

Finally, the SEC alleged that BlockFi failed to register as an investment company under the Investment Company Act (ICA).  The SEC found that BlockFi qualified as an investment company under the ICA’s Section 3(a)(1)(C) — the provision defining so-called “inadvertent investment companies” — because BlockFi issued securities (the BIAs), engaged in the business of investing in securities and held more than 40% of its total assets in “investment securities.”  In a dissenting statement, SEC Commissioner Hester M. Peirce criticized the decision to include an ICA violation in the order because BlockFi, as an issuer of debt securities, could not register as an investment company.^[5]  According to Commissioner Peirce, the additional charge under the ICA afforded investors no additional protections.

In announcing the settlement, the SEC Enforcement Division head Gurbir S. Grewal said “[c]rypto lending platforms offering securities like BlockFi’s BIAs should take immediate notice of today’s resolution and come into compliance with the federal securities laws.”  This statement aligns with the SEC’s 2021 enforcement actions signaling a focus on crypto lending products, including a complaint against promoters of BitConnect’s lending program for offering an unregistered sale of securities,^[6] a settlement with Blockchain Credit Partners for its sale of two digital tokens, including one that offered interest payments,^[7]  and a Wells Notice to Coinbase warning it not to proceed with plans to offer its Lend product.^[8]

The BlockFi settlement also shows that states have not ceded crypto enforcement to federal regulators.  In conjunction with the SEC’s order, the North American Securities Administrators Association (NASAA) announced a $50 million settlement against BlockFi.^[9]  Thirty-two state regulators have already agreed to a settlement to resolve BlockFi’s alleged past unregistered activities, with more jurisdictions expected to follow.  Each of the 53 U.S. jurisdictions that are members in NASAA will be entitled to an equal share of the $50 million settlement after executing consent orders.

Although the way forward for firms seeking to offer crypto lending products remains murky, as does the question of which such products constitute securities, the BlockFi order hinted at a narrow path for crypto lending products to satisfy the SEC’s concerns.  The order acknowledged that BlockFi intends to seek SEC approval for a new investment product, BlockFi Yield, which, if approved, will become the first interest-bearing crypto product to register with the SEC.^[10]  This path, however, would impose significant regulatory burdens on the issuer, including the requirement to register as an investment company or take steps to avoid becoming one.  In her dissenting statement, Commissioner Peirce warned that the order may well “stop [retail crypto lending products] from being offered to retail customers in the United States.”

^[1] In the Matter of BlockFi Lending LLC, Administrative Proceeding File No. 3-20758 (Securities and Exchange Commission, Feb. 14, 2022), https://www.sec.gov/litigation/admin/2022/33-11029.pdf.

^[2] Press Release, Securities and Exchange Commission, BlockFi Agrees to Pay $100 Million in Penalties and Pursue Registration of Its Crypto Lending Product (Feb. 14, 2022), https://www.sec.gov/news/press-release/2022-26.

^[3] SEC v. W.J. Howey Co., 328 U.S. 293, 298–99 (1946).

^[4] Reves v. Ernst & Young, 494 U.S. 56, 64–66 (1990).

^[5] Hester M. Peirce, Statement on Settlement with BlockFi Lending LLC, Securities and Exchange Commission (Feb. 14, 2022), https://www.sec.gov/news/statement/peirce-blockfi-20220214.

^[6] SEC v. Brown et al., Case No. 1-21-cv-04791 (S.D.N.Y. May 28, 2021), https://www.sec.gov/litigation/complaints/2021/comp-pr2021-90.pdf.

^[7] In the Matter of Blockchain Credit Partners, Administrative Proceeding File No. 3-20453 (Securities and Exchange Commission, Aug. 6, 2021), https://www.sec.gov/litigation/admin/2021/33-10961.pdf.

^[8] Olga Kharif & Joanna Ossinger, Coinbase Gets Wells Notice from the SEC on Lend Product, Bloomberg (Sept. 7, 2021), https://www.bloomberg.com/news/articles/2021-09-08/coinbase-gets-wells-notice-from-the-sec-on-its-lend-product.

^[9] Press Release, North American Securities Administrators Association, NASAA and SEC Announce $100 Million Settlement with BlockFi Lending, LLC (Feb. 14, 2022), https://www.nasaa.org/62000/nasaa-and-sec-announce-100-million-settlement-with-blockfi-lending-llc/?qoid=current-headlines.

^[10] BlockFi, Regulatory Developments, available at https://blockfi.com/regulatory-developments/.