Bitcoin Regulation: SEC Calls Mining Contracts ‘Securities’

With the SEC charging Homero Joshua Garza with security fraud, a little noticed precedent regarding bitcoin regulation may be on the verge of being set: The SEC is classifying mining contracts as securities.

As mentioned in my recent interview with the President of the Chamber of Digital Commerce, Perianne Boring, different regulatory bodies have been treating bitcoin in different ways and are seemingly classifying it as one thing even while another department is classifying it as something completely different.

In the initial SEC complaint against Garza and his companies, the SEC described Garza’s Hashlets as an investment contract and thus a security, stating simply that “Hashlets constitute investment contracts, and thus ‘securities’ under Section 2(a)(1) [15 U.S.C. §77b(1)] of the Securities Act.”

This potentially precedent setting development went mostly unnoticed by the press, possibly because there was so little to chew on. We knew from the complaint that the SEC sees mining contracts like Garza’s Hashlets to be comparable enough to investment contracts that they feel it falls under their jurisdiction, but we didn’t know their reasoning behind it.

With the SEC requesting a default judgement of $10 Million against GAW Miners and ZENMINER, a bit more of their reasoning has come to light. In the request for default judgement, attorney Kathleen Shields makes the SEC’s case on why Hashlets and other bitcoin mining contracts should be considered investment contract, and therefore a “security” by the court.

“The definition of ‘security’ under both Section 2(a)(1) of the Securities Act and Section 3(aX10) of the Exchange Act includes an “investment contract.” 15 U.S.C. §776(1); 15 U.S.C. §78c(a)(10). Under both statutes, an investment contract ‘means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.'”

The point the SEC seems to be making here is that any time investors invest into a company or person and are expected to receive profits based solely on the efforts of the company or people invested in and investor money is put into a common pool, then that is an investment contract. In addition, the law is flexible. The complaint quotes the Security and Exchanges Act as stating that the law is “capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”

As the complaint goes on to point out, Garza and his companies sold the hashlets as a share in the companies’ profits from bitcoin and altcoin mining. The profits allegedly never existed and payouts instead came from new investors.

Cloud Mining contracts of all types, not just Garza’s Hashlets, seem like they would fit inside the SEC definition of a security. What this means from a legal perspective for existing cloud mining companies, is not immediately clear. Garza and his companies are accused of defrauding investors by making false or misleading statements, any honest company should be safe from that.

However, there are specific rules in the United States about offering securities to “Non-accredited investors”. Previously, it was illegal in the United States to offer securities in that way but as of October 2015, the SEC issued new rules, permitting companies to offer securities to non accredited investors in a limited way, through “Crowdfunding.” It is not immediately clear how or if that would apply to cloud mining companies or bitcoin regulation in general.

Precedent will only be set when and if Garza and his companies are found guilty of the crimes they are accused of. Bitcoin companies, meanwhile, will have an increasingly complex regulatory landscape to navigate. While the SEC asserts that bitcoin mining contracts are securities, the FBI has declared Bitcoin as “property” while FinCEN seems to be regulating it as a currency.

This increasing complexity, confusion and at times inconsistency of the government’s policy towards bitcoin regulation only highlights the importance of continuing the discussion on Bitcoin regulation between the various government agencies and the Bitcoin industry. That discussion is set to make a major step forward at the DC Blockchain Summit early next month.

[Photo: Scott S.]