Explained | Why did the U.S. SEC charge Kim Kardashian for ‘touting’ cryptocurrency?

The story so far: North American TV star Kim Kardashian on Monday agreed to pay $1.26 million as fees and penalties to settle charges levelled by the United States’ Securities and Exchange Commission (U.S. SEC). The regulatory body found her guilty of touting a crypto asset, offered and sold by EthereumMax, through her social media account without disclosing the payment she received for its promotion. 

As per the order, the reality TV star, known for chronicling her life in Keeping Up with the Kardashians (2007-21) has neither denied nor admitted to the findings. She agreed to not promote any crypto assets for three years as well as cooperate with the commission’s ongoing investigation. “This case is a reminder that, when celebrities or influencers endorse investment opportunities, including crypto asset securities, it doesn’t mean that those investment products are right for all investors,” SEC Chair Gary Gensler stated. 

Where is the violation?  

Ms Kardashian did not disclose that she received $250,000 for promoting EMAX tokens, offered by EthereumMax, on her Instagram account, which has 225 million followers. The promotional post was captioned, “This is not financial advice but sharing what my friends told me about the Ethereum Max token!” 

The post also had a link to EthereumMax’s website providing instructions to potential investors about purchasing EMAX tokens. The latter helps mine the crypto-coin.  

The socialite’s actions were in violation of Section 17 (b) of the Securities Act. The section deems it unlawful for an individual to publicise or circulate any promotional material or communication without disclosing the nature, sources and amount of compensation they received in exchange for the promotion. This ensures transparency and tackles concerns pertaining to potential bias towards the publicised security.  

The second-eldest Kardashian sibling is also named in a lawsuit along with former NBA player and TV personality Paul Pierce and Boxer Floyd Mayweather. The trio is alleged to have made misleading claims about EMAX tokens that led to investors incurring heavy losses. In fact, after ESPN fired Mr Pierce last year, he tweeted about having made more money with the crypto asset than with the channel.  

EthereumMax claims to be a progressive ERC-20 token built on the secure Ethereum network token, which is the among the world’s most popular cryptocurrencies.  

As per the lawsuit, following promotional activities in May, prices of the speculative asset had indeed surged. However, the rise did not last long with prices deflating immediately after Ms Kardashian’s post. On July 15, prices had dropped 98%, and, as per the petitioners, had not recovered until the lawsuit was filed in July this year. 

Have there been previous instances too? 

The lawsuit alleges that the company’s entire business model is centred around marketing and promotional activities, including those with celebrities. It further alleges that the coin is based on a ‘pump-and-dump’ market manipulation, which involves touting a security’s potential through false and misleading endorsements inthe marketplace. Once the objective is achieved or a break-even point has been attained, the hype ceases and prices fall, causing investors to lose money. 

It was in 2018 that the U.S. SEC first settled charges pertaining to touting violations (specifically involving initial coin offerings) with music composer DJ Khaled and Mr Mayweather. The same year, the United States’ Federal Trade Commission (FTC) had said that anyone promising a guaranteed return or profit is a potential scammer. “Just because the cryptocurrency is well-known or has celebrities endorsing it doesn’t mean it’s a good investment,” it added.  

Several cryptocurrencies are speculative assets and not a recognised fiat currency. They exist only in the virtual world, unlike a fiat currency which has both electronic and physical shapes. It was in July this year that the Federal Bureau of Investigation (FBI) put Bulgarian-born Ruja Ignatova to its ‘Top Ten Most Wanted Fugitive List’ for allegedly floating a purported cryptocurrency. 

The FTC stated in July this year that since the start of 2021, more than 46,000 people reported losing over $1 billion in crypto to scams. This amounts to about one out of every four dollars reportedly lost to fraud during this period. 

It is for this reason that Section 5 of the Securities Act focuses on ensuring “full and fair disclosure”. Those who offer and sell securities must comply with registration requirements as per federal security laws. This applies to both sale/purchase of securities as well as entities engaging in activities on an exchange, thus ensuring procedural protections and a mechanism to facilitate information necessary to make informed investment decisions. 

However, as pointed out by the SEC in a 2017 Report, the central issue is “whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.” 

How is the scenario back home? 

Manisha Kapoor, CEO & Secretary General at the self-regulatory organisation Advertising Standards Council of India (ASCI), told The Hindu that influencers do make up a large part of advertising around virtual digital assets. “Given that it is a new sector and a new technology aimed at millennials and Gen Z, we can surmise that it is the influencers, who form a chunk of advertising in this space,” she said.  

She stated that of more than 453 advertisements on virtual digital assets that were found to be flouting ASCI guidelines, 447 were related to influencers. 

“Often, we notice some influencers talking confidently about crypto without understanding or mentioning the risks attached. Several of them do not even mention the mandatory disclaimer or disclosure, a violation of the ASCI guidelines,” Ms Kapoor observed. She opines that since virtual digital assets are new technologies, people need to be made aware of the associated risks.  

In February this year, the ASCI published ‘Guidelines for Virtual Digital Assets and Linked Services. These guidelines mandate that all advertisements of virtual products and exchanges must carry a disclaimer stating, “Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory resources for any loss from such transactions.” Among other things, it asks celebrities to carry out due diligence with regard to the statement and claims made in the advertisements, so as to not mislead potential customers. 

In fact,  The Hindu Businessline learnt from sources earlier in May that the Securities and Exchange Board of India (SEBI) had told the Parliamentary Standing Committee on Finance that given that “crypto products are unregulated, prominent public figures including celebrities, sportsmen, etc. or their voice shall not be used for endorsement/advertisement of crypto products.” 

ASCI observed an overall compliance rate of 94% across all platforms combined, namely, print, digital and television. 

Also deeming it a speculative asset, apex banking regulator Reserve Bank of India (RBI) observed in its Financial Stability Report (published in June this year) that typically created on decentralised systems, cryptocurrencies are designed to bypass the financial system and its controls, including anti-money laundering, anti-financial terrorism and know-your-customer (KYC) regulations. They are also characterised by highly volatile prices.

It added, “Historically, private currencies have resulted in instability over time and in the current context, (may) result in ‘dollarisation’, as they create parallel currency system(s), which can undermine sovereign control over money supply, interest rates and macroeconomic stability.” 

It is for the same reason that the U.S. SEC has been trying to regulate crypto-currency markets, accompanied by fears about a potential recession, rising interest rates and geopolitical turmoil.