The SEC announced yesterday a settlement with Bitcoin Investment Trust (BIT) and SecondMarket, Inc. (SecondMarket).  According to the Administrative Order, the SEC claims that BIT and SecondMarket redeemed BIT shares during an ongoing distribution and, therefore, violated Rules 101 and 102 of Regulation M.

Regulation M is intended to prevent potentially manipulative practices by underwriters, issuers, selling security holders and other participants in securities offerings.  It attempts to accomplish this goal by precluding certain types of trading activities that could artificially raise the price of a security or create a false appearance of active trading in the market by investors.  In particular, Rule 101 of Regulation M prohibits any “distribution participant” from directly or indirectly bidding for, purchasing or attempting to induce any person to bid for or purchase a covered security during a “restricted period” in connection with a distribution of securities.  Similarly, Rule 102 of Regulation M prohibits issuers, selling security holders or any affiliated purchaser from the same type of activity.

According to the SEC, BIT was formed as a private Delaware trust whose sole assets were bitcoins.  In September 2013, BIT began selling shares.  Due to the size of the offering and the special selling efforts, the offering constituted a “distribution.”  In April 2014, SecondMarket, the sole Authorized Participant for BIT shares, began accepting orders to redeem shares from BIT shareholders.  Between April and September 2014, the SEC claimed that SecondMarket purchased 8,721 BIT shares from shareholders.  The SEC claims that these purchases of BIT shares occurred during a continuous distribution of BIT shares and, therefore, violated Rule 101 of Regulation M.  Similarly, between November 4, 2013 and September 4, 2014, BIT purchased 6,479 shares from SecondMarket during a continuous distribution of BIT shares and, therefore, violated Rule 102 of Regulation M.

Without admitting or denying the findings, BIT and SecondMarket settled the administrative proceeding and agreed to cease and desist from committing or causing any future violations of Rules 101 and 102 of Regulation M.  In addition, SecondMarket agreed to pay disgorgement of $51,650 and prejudgment interest of $2,105.

The SEC’s settlement is noteworthy for several reasons:

• The SEC Is Carefully Looking at the Distribution of FinTech Company Shares
• The SEC Sets Forth a Definition of Bitcoin – “[A] digital representation of value that can be digitally traded and functions as a medium of exchange; a unit of account; and/or a store of value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction. It is not issued or guaranteed by any jurisdiction, and fulfills the above functions only by agreement within the community of users of the virtual currency.  Virtual currency is distinct from fiat currency, which is the coin and paper money of a country that is designated as its legal tender; circulates; and is customarily used and accepted as a medium of exchange in the issuing country.  It also is distinct from e-money, which is a digital representation of fiat currency used to electronically transfer value denominated in fiat currency, i.e., e-money electronically transfers value that has legal tender status.”
• The SEC Takes Into Consideration Reliance on Counsel – The federal securities laws are quite complex and can be difficult to navigate, even with experienced counsel.  In determining an appropriate settlement, the SEC specifically noted that the settlement was based on the fact that SecondMarket and BIT sought and received legal advice regarding the development and implementation of the program.