FINRA’s First Disciplinary Action Involving a Cryptocurrency Serves as a Cautionary Tale for Investors

Posted on by

By Theodore O’Brien

The Financial Industry Regulatory Authority (FINRA) ushered in a new era of securities regulation by filing a complaint against a Massachusetts man, charging him with fraud and the unlawful distribution of unregistered cryptocurrency securities.

Cryptocurrencies like Ripple and Ether have captured the popular imagination because the underlying blockchain technology allows users to exchange payments without involving a third party, like a bank, potentially making transactions more efficient and more secure. While regulators have cautioned investors about the risks of cryptocurrencies, the problem lies not with the technology itself, but rather when a cryptocurrency is offered as an unregistered security.

The complaint, brought by FINRA’s Department of Enforcement against Timothy Ayre, illustrates how an individual may take advantage of the public’s interest in cryptocurrency to bail out a failing business, violating securities laws in the process. In 2015, Ayre bought the rights to HempCoin, a cryptocurrency, and promised investors that by purchasing the coins they were also acquiring common stock in Rocky Mountain Ayre (“RMTN”), a failing public company with no real assets. Ayre told investors that every 10 HempCoins was backed by 1 share in RMTN, the public company. However, HempCoin was never registered as a security and, therefore, Ayre violated securities laws by attaching an equity interest in a public company to HempCoin. Ayre misled investors with statements describing HempCoin as “the world’s first currency to represent equity ownership” so that investors would mine and purchase HempCoins thinking they the coins were backed by a publicly-traded company. To make matters worse, Ayre attracted investors with allegedly false statements about RMTN’s business; he suggested it was a healthy diversified financial planning company, when in reality RMTN was a holding company with no underlying business.

The problem, of course, is that Ayre failed to register the new security and ran afoul of several securities laws and regulations by offering an unregistered security to the public. Under Section 5 of the Securities Act of 1933, it is illegal to sell an unregistered security. Ayre needed to either register HempCoin securities with the Securities and Exchange Commission or satisfy an exemption from registration. He did neither and in the course of selling the HempCoins as securities to investors he made materially false statements and omissions regarding both the purported security and RMNT. According to the complaint, this fraudulent conduct violated Section 10(b) of the Securities Exchange Act of 1934 and FINRA Rules 2010 and 2020. Finally, the complaint alleges that Ayre executed transactions involving more than 500 million shares of RMNT stock and yet failed to disclose those transactions to his broker-dealer, violating FINRA Rule 2010, NASD Rule 3040, and FINRA Rule 3280.

In spite of HempCoin’s status as an unregistered security, cryptocurrency investors “mined” more than 81 million HempCoins from June 2015 until at least late 2017. Other investors purchased the coins on cryptocurrency exchanges like C-Cex and Yobit.

It is important to note, as FINRA states in the press release:

“The issuance of a disciplinary complaint represents the initiation of a formal proceeding by FINRA in which findings as to the allegations in the complaint have not been made, and does not represent a decision as to any of the allegations contained in the complaint. Under FINRA rules, a firm or individual named in a complaint can file a response and request a hearing before a FINRA disciplinary panel.”

This complaint is remarkable because it is FINRA’s first disciplinary action involving cryptocurrency. It is also an important reminder to investors to be wary of unregistered securities. FINRA has specifically cautioned investors about cryptocurrency-related schemes. Although cryptocurrency represents an exciting new technology, investors should not be so caught up in the potential that they fail to exercise due diligence and conduct investment research.

As this blog noted earlier this year, cryptocurrencies pose unique risks to unsophisticated investors because regulators have been slow to catch up with the emerging technology (and related scams).