Scrutiny of the cryptocurrency industry continues to grow, with both state and federal regulators arguing that more needs to be done to protect investors. On October 19, 2023, the New York Office of Attorney General filed suit against cryptocurrency companies Gemini Trust Company (Gemini), Genesis Global Capital, LLC, and its affiliates (Genesis), and Digital Currency Group, Inc. (DCG), alleging that the companies defrauded investors out of more than $1 billion.

Separately, the Securities and Exchange Commission (SEC) Chair Gary Gensler made it clear that the SEC also isn't taking its foot off the accelerator when it comes to crypto enforcement. In a speech delivered on October 25, 2023, at the 2023 Securities Enforcement Forum, Gensler highlighted the SEC's crypto enforcement successes and vowed to continue pursuing bad actors. "This is a field rife with fraud, scams, bankruptcies, and money laundering," he said. "It's reminiscent of what we had in the 1920s before the federal securities laws were put in place."

On October 19, 2023, New York Attorney General Letitia James filed a lawsuit against Gemini, the cryptocurrency exchange founded by the Winklevoss twins. She also targeted Genesis, a significant institutional cryptocurrency lender, involved in the Gemini Earn investment program. Under the program, investors deposited their digital assets with Gemini, and Genesis then lent them out to third parties, promising returns of up to eight percent.

The NY OAG suit alleges that DCG and Genesis concealed losses by entering a $1.1 billion promissory note. DCG agreed to pay Genesis $1.1 billion over a decade with a one percent interest rate. Gemini concealed risky loans from investors, including high concentration with Sam Bankman-Fried's Alameda, according to the lawsuit. Investors were not informed.

Genesis is accused of hiding over $1.1 billion in losses from investors, Gemini, and the public. In June 2022, one of Genesis' largest borrowers, Three Arrows Capital, defaulted on billions in loans. Around the same time, Genesis lost more than $100 million from another borrower, Babel Finance. In total, Genesis had lost more than $1.1 billion, according to the suit.

A Closer Look at the NY OAG's Lawsuit and Its Implications for Crypto Defendants

The NY OAG's suit maintains that to conceal these losses, DCG and Genesis entered into a $1.1 billion promissory note, in which DCG agreed to pay Genesis $1.1 billion in a decade at only a one percent interest rate. The lawsuit alleges the promissory note aimed to defraud Gemini Earn investors and deceive the public about Genesis' financial status. "Gemini hid the risks of investing with Genesis and Genesis lied to the public about its losses," said James.

The lawsuit could have serious repercussions for all of the crypto defendants. NYOAG aims to ban Gemini, Genesis, DCG, and their executives from New York's securities and commodities transactions. The suit also seeks restitution for all defrauded investors and disgorgement of all ill-gotten gains.

SEC Crypto Enforcement

The SEC initiated a suit against Genesis and Gemini this year for unregistered securities related to Earn.

The agency took high-profile actions this year, targeting individuals like Samuel Bankman-Fried and Changpeng Zhao, along with Coinbase Global.

The ongoing debate over when crypto assets constitute securities has not slowed the SEC's enforcement actions. In his speech, Gessler reiterated his stance that many crypto assets meet the Howie test used to determine whether a transaction qualifies as an investment contract and, thus, is considered a security under federal law. "Without prejudging any one asset, the vast majority of crypto assets likely meet the investment contract test, making them subject to the securities laws," Gessler stated. He argued that crypto intermediaries dealing with these assets are also subject to securities laws.

Of course, many crypto companies do not share the SEC's stance. Several of the agency's enforcement targets, including Coinbase, have challenged the agency's crypto authority. These suits could clarify crypto asset classification as securities, requiring close monitoring by affected entities.

Key Takeaway

Regulators, like the SEC and NY AOG, target unregistered securities and actively combat crypto-based investment fraud. Before financial engagements, both crypto businesses and investors should prioritize thorough due diligence to prevent potential losses.

Originally published December 28, 2023

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