Dragonchain Sued by SEC Amidst Crypto Crackdown – Charged with Illegal Unregistered Securities Offerings

Dragonchain

The Securities Exchange Commission is pursuing charges against blockchain-company Dragonchain, alleging that the 2017 ICO and subsequent offers and sales of their DRGN token, which raised over $16.5 million in proceeds, were illegal sales of unregistered securities.

The Securities and Exchange Commission (“SEC”) issued a lawsuit this past week against a blockchain-based cryptocurrency company amidst a string of crypto-related enforcement actions the public has labeled the “crypto crackdown.”1 On August 16th, 2022, the SEC filed a complaint against Dragonchain, a cryptocurrency blockchain platform self-coined as “America’s Blockchain,”2 charging the company and affiliated entities with the illegal offering and sale of unregistered securities pursuant to The Securities Act of 19333 (”Securities Act).

The 17-page complaint alleges that from 2017-2022, defendants Dragonchain, Inc. (”Dragonchain”), John Joseph (Joe) Roets, the Dragonchain Foundation (the ”Foundation”), and The Dragon Company (”TDC”) engaged in unregistered offers and sales of Dragonchain’s crypto asset, the Dragon Token (“DRGN”),4 violating Section 5 of the Securities Act5 and illegally raising more than $16 million in proceeds from roughly 5,000 investors worldwide.

Dragonchain is a hybrid-blockchain platform designed for the commercial use and development of blockchain applications on the promise of simplicity, scalability and security.6 Joe Roets, architect and acting CEO of Dragonchain, originally developed the platform at the Walt Disney Company in 2014. the project was open-sourced two years later, and has since been maintained by the the Foundation.7 Roets explained his vision for the project during its 2017 launch stating: “when we created Dragonchain, we wanted to build an easy-to-use hybrid blockchain platform that has all the benefits of immutable proof on the public blockchain, in a flexible business-focused package.”8

This lawsuit follows nearly 4 years of SEC investigation and communication with Dragonchain, who deny all allegations and claim they were led to believe the investigation was “dying down” by their attorneys back in 2021.9 After receiving notice that investigators were planning to recommend the SEC pursue charges, Roets released a response letter on behalf of Dragonchain in which he expressed their confidence in having “a very strong case against any charges should they be filed.”10

The SEC is requesting permanent injunctions and civil penalties for each defendant, and the return of all profits believed to be illegally obtained.11

The official complaint is available on the SEC’s website here.

From Disney to Dragonchain

In 2017, shortly after Disney released the open source code formally known as the “Disney Private Blockchain Platform,”12 the Dragonchain Foundation was created as a Non-Profit Corporation to represent and maintain the ownership and responsibility of the code.13

Dragonchain serves as a “platform for creating smart contracts and an ecosystem of pre-built library smart contracts, qualified vendors, specialized experts, and incubated projects.”14

The company claims the problem with existing blockchain platforms is the difficulty to produce both secure and scalable applications that can be used within real world business models. Its goal was to solve the issue by providing the following fundamentals: (i) protection of business data & operational smart contracts, (ii) a scalable system via serverless deployment, (iii) the creation of smart contracts with established, general purpose languages and, (iv) an ecosystem for sharing and monetization of smart Contracts.15 Dragonchain’s 2017 vision statement describes the purpose behind the company, saying it “empowers security, scale, and coding flexibility on a business focused blockchain platform.”16

Cease and Desist: The Warning

While Dragonchain stands firm in their denial of any securities laws violation, the Securities Division of Washington’s Department of Financial Institutions determined the DRGN token to be a security back in January 2021.17 The Securities Division issued a consent letter to Dragonchain on nearly identical allegations as those set forth in the SEC complaint, to which Dragonchain neither admitted nor denied. The Department’s letter, which accused the company of violating Chapter 20 of the Securities Act of Washington,18 concluded the following:

  1. The offer and sale of DRGNs during the ICO met the criteria of the offer and sale of ‘securities’ as defined in RCW 21.20.005(14) and (17);19
  2. Dragonchain was in violation of RCW 21.20.140 by failing to register those offers and sales;20 and,
  3. Dragonchain had failed to disclose necessary information to investors, or provided misleading information, violating RCW 21.20.010 21

The company was ordered to cease and desist all actions deemed violations and had to pay a $50,000 fine plus $10,000 in investigative costs.

Securities and Exchange Commission (SEC)

SEC Files Complaint

Key Allegations

  1. Dragonchain engaged in excessive efforts to attract investors;
  2. The DRGN token constitutes a security,22 and therefore,
  3. The unregistered offers and sales of DRGN were unlawful; and,
  4. The lack of registration prevented investors from receiving necessary and accurate disclosures.

The SEC lawsuit claims that in efforts to fund the company’s further development and marketing, Dragonchain held an Initial Coin Offering (”ICO”)23 of their token, DRGN, from October to November of 2017, raising over $12 million in both US and crypto currency from roughly 5,000 investors.24 Dragonchain alledgedly raised another $2.5 million from offers and sales from 2019-2022. By December of 2017, two months following their ICO, the company’s worth exceeded $50 million, and in January of 2018 the DRGN token sold for more than $5 each, bringing the value of Dragonchain to over $1.2 billion.25

In the complaint, the SEC alleges that the proceeds of the ICO and subsequent sales were used to develop their technology, including the “Turnkey Platform”26 and an “ecosystem,”27 which helped facilitate businesses’ adoption of the Turnkey Platform. DRGN investments were solicited directly from the public and marketed with explicit claims that the value of DRGN would increase as adoption of its technology grew and it’s ecosystem matured. It was made clear to purchasers of DRGNs that the proceeds of the offering would be used for advancements of its technology and for marketing purposes that would promote its adoption.

Dragonchain is being accused by the SEC of creating an “information vacuum” to control their intended market’s knowledge about DRGN and the company, stating “because Dragonchain never filed a registration statement for its offer and sale of DRGNs, it never provided investors with the material information that other issuers include in such statements when soliciting public investment.”28

The Defendants

The complaint names four defendants:

  1. Dragonchain, Inc.,
  2. Joseph Roets,
  3. Dragonchain Foundation, and
  4. The Dragon Company

Roets is named as Founder and primary decision maker for all entities, deeming him a “necessary and substantial participant” in the entity’s alleged securities laws violations, and the SEC emphasizes that, “he personally committed the violations.”29

The Foundation is intrinsically in control of the code, the purpose of its very creation being to represent and maintain ownership and responsibility.30 The Foundation allegedly received a large portion of the proceeds from the offers and sales of DRGN over the last 5 years, as well as a portion of the DRGNs that were minted but never sold. Roets, who serves as the Foundation’s chairman, and the President of the Foundation are both called out in the complaint for publicly associating themselves with Dragonchain and the offers of DRGN while holding managerial roles.

TDC31 was purportedly used to pay Dragonchain service providers with DRGN owned by Dragonchain and The Foundation and subsequently executed millions of dollars worth of sales and transfers of DRGN. The lack of restrictions allowed them to flow directly to the open market.

Relief and Damages

The SEC is asking that Roets, Dragonchain, the Foundation, and TDC be prohibited from participating in any future crypto assets securities offerings. However, the complaint also notes that Roets may still participate in purchasing and selling securities for his personal accounts, with the exception of DRGNs. The defendants are ordered to pay civil penalty fines, as well as pay back all the earnings from the aforementioned transactions.

Dragonchain Responds to Notice

On April 27th, 2022, Roets, Dragonchain, TDC and the Foundation received notice from the SEC informing the parties that they intended to press charges. In response, on May 19th, 2022, Roets posted an open letter on behalf of Dragonchain touting the value of the blockchain technology, calling it “liberty encapsulated in software”32and condemning the SEC for it’s approach to regulating the industry.

The response letter explains the history, goals and architecture behind Dragonchain in an effort to denounce its classification as a security, claiming the involved parties should not be charged for intentional or unintentional violations.

In the letter, Roets calls the SEC’s regulatory process of digital assets a “racket,” stating: “it appears to be designed to efficiently drain the funds and energy of a targeted project, and to harass the creators of software in our industry.33 He voices many “ethical concerns” over the enforcement actions, arguing the charges could potentially violate the constitutional rights of free speech,34 due process,35 and equal protection.36

The question that seems to be at the forefront of the SEC’s crypto-regulation is whether or not the existing securities laws are appropriate for governing crypto securities; many industry participants are calling for digital asset-specific legislation.37 Roets’ SEC Response Letter states “the commission is trying to shoehorn software technology into incompatible securities law from the 1930’s. This calls into question whether the Commission understands the technology enough to effectively regulate it.”38 He closes the preamble with a quote from Thomas Paine: “Tyranny, like hell, is not easily conquered; yet we have this consolation with us, that the harder the conflict, the more glorious the triumph.”

SEC v. Dragonchain, Inc., et al. marks the 11th enforcement action involving crypto assets in 2022.39 Reports of investigations continue to circulate naming some of world’s largest crypto exchanges and entities, as the SEC stakes its claim to the crypto industry40 by means of what the Commodity Futures Trading Commission (”CFTC”) has declared “regulation by enforcement.”41 SEC Commissioner Hester Peirce also questioned the SEC’s actions in a recent tweet, stating “The SEC is a regulatory agency with an enforcement division, not an enforcement agency. Why are we leading with enforcement in crypto?”42

It is unlikely the SEC will slow down its regulatory enforcement any time soon and the power struggle of crypto jurisdiction between the SEC and CFTC will continue until legislative intervention.

Unique Factors and Firm Opinions

A key component of this case is the solicitation and profit from public funds. Section 4 of the Securities Act distinguishes between (1) the sale of securities by issuers into public markets, and (2) traditional trade transactions by investors in the market, and Section 5 requires that the public offers and sales be registered.43 According to the SEC, Dragonchain offered and sold DRGNs directly to the public; the token was offered “broadly and widely to all potential purchasers, not just those who might be reasonably expected to ‘use’ dragons.”44 The offer and sale of DRGNs was marketed using interstate commerce to promote investment, and the funds raised were pooled and used to fund the operations of Dragonchain and its technology.45

Regardless of the outcome of this case, it is my opinion that most digital assets are in fact not securities. Furthermore, it is unclear if the SEC is correct and within its jurisdiction with this lawsuit, but the SEC did lay out some good arguments, which Dragonchain should work with securities counsel.

The SEC complaint demands a trial by jury, but it isn’t definite if the case will make it that far. Dragonchain revealed that during the investigation they were previously unofficially offered a settlement but declined because the SEC couldn’t provide adequate information about the outcome of the proposed settlement.46 Whether or not they will rethink their decision if a new settlement is offered in light of the formal complaint remains to be seen. Many of the accusations within the SEC complaint are directly contradicted by statements made in Dragonchain’s published response; should the case go to trial, it will be up to the jury to decide the truth.

The named defendants have not yet responded to the official complaint, but Montague Law is monitoring the case process closely and will provide an update with any future correspondence.

 

The information provided on this website does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. Securities law is complex and highly fact specific to any given circumstance and readers should contact an attorney for advice regarding any type of legal matter.


1E.g., MacKenzie Sigalos, Crypto Crackdown: Why federal charges over an alleged Ponzi scheme may only be the tip of the iceberg, CNBC, (Aug. 2, 2022, 7:35 AM), https://www.cnbc.com/video/2022/08/02/crypto-crackdown-why-federal-charges-over-an-alleged-ponzi-scheme-may-only-be-the-tip-of-the-iceberg.html; Sara Morrison, The Crypto Crackdown Begins, Vox (Aug. 3, 2022, 11:30 AM), https://www.vox.com/recode/2022/8/3/23290388/crypto-illegal-scams-lawsuit-sec
2About Dragonchainhttps://dragonchain.com/about/ (last visited August 24, 2022)
3S.E.C. v. Dragonchain, Inc. et al., No. 2:22-cv-01145, W.D. Wa. filed August 16, 2022, https://www.sec.gov/litigation/complaints/2022/comp25468.pdf.
4Dragonchain, Fundamentals (2017), 
https://docs.google.com/presentation/d/10Zhvs4R7cJqUvv7Q5h1gLHr7R6i0Wo59nXGTPED3nPg/htmlpresent. The Fundamentals document provided by DC in 2017 defines the Dragon as “a tokenized micro-license (PATENT PENDING) for interaction with Dragonchain’s commercial platform services which captures legal guidance regarding US Securities law.” It also includes a disclaimer stating, “Dragon is not a financial security and should not be purchased for investment or speculative purposes. Purchasers of Dragons should have a bona fide intention to use them for interaction with the Dragonchain platform,”
5The Securities Act of 1933, as amended, 15 USCS § 77a et seq.; Section 5 of the Act mandates that any issuer of non-exempt securities to the public must register offers and sales with the Securities and Exchange Commission (SEC); the absence of such registration deems any subsequent offer and sale unlawful and subject to liability; Legal Information institute, The Securities Act of 1933, Cornell Law School, https://www.law.cornell.edu/wex/securities_act_of_1933. “The goal is to provide investors with accurate information so that they can make informed investment decisions.”
6Hybrid Blockchain Platform for Flexibility, Scalability, and Security, https://dragonchain.com/blockchain-platform(last visited August 24, 2022).
7Dragonchain™, Originally Developed at Disney, Announces October 2nd ICO to Simplify Blockchain Technology for Business Use, BusinessWire (Sep. 20, 2017, 3:00 AM), https://www.businesswire.com/news/home/20170920005471/en/Dragonchain™-Originally-Developed-Disney-Announces-October-2nd
8Id.
9Todd Bishop, SEC sues Dragonchain, alleging that $16.5M in crypto sales were illegal securities offerings,GeekWire (Aug. 16, 2022, 6:12 PM), https://www.geekwire.com/2022/sec-sues-dragonchain-alleging-that-16-5m-in-crypto-sales-were-illegal-securities-offerings/
10Response to SEC Letter, BusinessWire (May 19, 2022), https://drive.google.com/file/d/1yipAxDM7fN3snXpwzHqj6vq0SvSseMQa/view.
11S.E.C. v. Dragonchain, Inc. et al.supra note 3.
12Beck Peterson, Disney built a blockchain, and now its creators are trying to turn it into a commercial platform to compete with Ethereum, Business Insider (Oct. 1, 2017, 8:30 AM), https://docs.google.com/presentation/d/10Zhvs4R7cJqUvv7Q5h1gLHr7R6i0Wo59nXGTPED3nPg/htmlpresent.13About The Foundationhttps://dragonchain.org (last visited August 24, 2022)
14 Pink Panther, Fundamental Analysis of DragonChain (DRGN), Medium (Oct. 6, 2017), https://medium.com/@kkv54419/fundamental-analysis-of-dragonchain-drgn-1463cc971e8f
15Fundamentals, supra note 4.
16Id.
17Consent Order, State of Wash. Dep’t of Fin. Ins., Sec Div., No.: S-18-2433-21-CO01, https://dfi.wa.gov/documents/securities-orders/S-18-2433-21-CO01.pdf
18Securities Act of Washington, RCW 21.20
19Id. RCW 21.20.005. Chapter 20, Section 14 of the Securities Act of Washington defines “sale” as “Sale” or “sell” includes every contract of sale of, contract to sell, or disposition of, a security or interest in a security for value. “Offer” or “offer to sell” includes every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value. Any security given or delivered with, or as a bonus on account of, any purchase of securities or any other thing is considered to constitute part of the subject of the purchase and to have been offered and sold for value; Chapter 20, Section 17 defines security as (17)(a) “Security” means any note; stock; treasury stock; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral-trust certificate; preorganization certificate or subscription; transferable share; investment contract; investment of money or other consideration in the risk capital of a venture with the expectation of some valuable benefit to the investor where the investor does not receive the right to exercise practical and actual control over the managerial decisions of the venture; voting-trust certificate; certificate of deposit for a security; fractional undivided interest in an oil, gas, or mineral lease or in payments out of production under a lease, right, or royalty; charitable gift annuity; any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities, including any interest therein or based on the value thereof; or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency; or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any security under this subsection. This subsection applies whether or not the security is evidenced by a written document.
20Id. 21.20.140. “It is unlawful for any person to offer or sell any security in this state unless: (1) The security is registered by coordination or qualification under this chapter; (2) the security or transaction is exempted, or (3) the security is a federal covered security.”
21Id. *21.20.10. “*It is unlawful for any person, in connection with the offer, sale or purchase of any security, directly or indirectly: (1) To employ any device, scheme, or artifice to defraud; (2) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading; or (3) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.”
22See The Securities Act of 1933, supra note 5.
23Glossary, Initial Coin Offering, W-015-0050, “Largely unregulated fundraising mechanism used for new cryptocurrency ventures. An ICO is similar to an initial public offering (IPO), however, in an ICO, investors purchase virtual currency tokens instead of equity shares. ICOs are sometimes used by startups to avoid the SEC’s strictly regulated capital-raising process, though the SEC and other regulators have begun scrutinizing ICOs.”
24S.E.C. v. Dragonchain, Inc. et al.supra note 3.
25Mitchell Moos, Slaying the Dragonchain: A Tale of Fear and Mania, CryptoBriefing (Aug. 26, 2022, 6:21 PM), https://cryptobriefing.com/slaying-the-dragonchain-a-tale-of-fear-and-mania/.
26S.E.C. v. Dragonchain, Inc. et al.supra note 3. “Blockchain software with which businesses could introduce blockchain technology could introduce blockchain technology into their daily activities”
27S.E.C. v. Dragonchain, Inc. et al.supra note 3. “A community of users, developers, and other service providers interacting with each other and with Turnkey Platform customers through Dragonchain-provided portals.”
28S.E.C. v. Dragonchain, Inc. et al.supra note 3.
29Id.
30S.E.C. vs. Dragonchainsupra note 3. The Foundation owns intellectual property rights to the code and technology used by both Dragonchain and TDC.
31S.E.C. v. Dragonchain, Inc. et al.supra note 3. TDC is a company that provides business optimization and project management services reportedly formed by Roets in 2019.
32Response to SEC Letter, supra note 10.
33Id.
34U.S. Const. amend. XIV. Software is free speech, therefore protected under the First Amendment; see also Alison Dame-Boyle, EFF at 25: Remembering the Case that Established Code as Speech (April 16, 2015), 
https://www.eff.org/deeplinks/2015/04/remembering-case-established-code-speech
35U.S. Const. amend. V.
36U.S. Const. amend. XIV
37See 17 C.F.R. 201.192(a)see also Press Release, Lummis, Gillibrand Introduce Landmark Legis. To Create Regul. Framework For Digital Assets (June 07, 2022),
https://www.gillibrand.senate.gov/news/press/release/-lummis-gillibrand-introduce-landmark-legislation-to-create-regulatory-framework-for-digital-assets
38Response to SEC Letter, supra note 10.
39Crypto Assets and Cyber Enforcement Actions, U.S. Securities Exchange Commission (Aug. 21, 2022), 
https://www.sec.gov/spotlight/cybersecurity-enforcement-actions
40See, Michael del Castillo, Every U.S. Crypto Exchange (And Binance) Is Being Investigated By The SEC, Says Senator Lummis Staffer, Forbes (Aug. 4, 2022, 7:08 PM), 
https://www.forbes.com/sites/michaeldelcastillo/2022/08/04/every-us-crypto-exchange-and-binance-is-being-investigated-by-the-sec-says-senator-lummis-staffer/?sh=3530893122c2
41See Statement of Commissioner Caroline D. Pham on SEC v. Wahi, Commodity Futures Trading Commission (July 21, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement072122.
42Hester Peirce (@HesterPeirce), Twitter, (May 5, 2022 11:10 AM), https://twitter.com/HesterPeirce/status/1521552802119663616.
43The Securities Act of 1933, supra note 5.
44S.E.C. v. Dragonchain, Inc. et al.supra note 3
45Id.
46Response to SEC Letter, supra note 10.

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The information provided in this article is for general informational purposes only and should not be construed as legal or tax advice. The content presented is not intended to be a substitute for professional legal, tax, or financial advice, nor should it be relied upon as such. Readers are encouraged to consult with their own attorney, CPA, and tax advisors to obtain specific guidance and advice tailored to their individual circumstances. No responsibility is assumed for any inaccuracies or errors in the information contained herein, and John Montague and Montague Law expressly disclaim any liability for any actions taken or not taken based on the information provided in this article.

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