Case Study: SEC v. Rari Capital Inc et al

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January 7th, 2025

Table of Content

Background

Legal Issues

Case Outcome

Broader Implications

Key Takeaways

References & Resources

Background

Industry Context

The SEC takes a critical view of crypto investing. They are strict overall with the requirements for the investing industry, and views discrepancies in the field of crypto investing seriously, specifically when it involves false marketing.

Company Details

Delaware corporation Rari Capital Inc, based in Los Angeles, California, was founded in June 2020 by Jack Lipstone, David Lucid, and Jai Bhavnani. Their other entity, Rari Capital Infrastructure LLC, formed in March 2022, was never registered with the SEC and never had any securities registered.

Key Events Leading to the Case

Rari Capital conducted unregistered sales of securities through their product offerings - Earn Pools and Fuse Pools. These two products functioned similarly to investment funds. Investors could deposit crypto assets into lending pools and thereafter earn returns on the investments.
The co-founders of Rari Capital also misled investors with the high annual percentage yield that they would receive. This misrepresentation led to a significant loss of funds for some investors.
A further misrepresentation to investors was the automatic and autonomous rebalance of the crypto assets into high yield generating opportunities. But the rebalancing was not automatic and required manual intervention by Rari Capital.
All operations on the Fuse platform were also faulted for their unregistered broker activity.

Legal Issues

Allegations/Claims/Violations

In this instance, not only was the company liable, but the three founding members. A variety of violations of the securities offering registration, anti-fraud provisions of federal securities laws as well as overall investor misrepresentation of the profitability of investment products:
“It shall be unlawful for any person in the offer or sale of any securities or any security-based swap agreement by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly –
(Section 17(a)(2) of the Securities Act of 1933) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statement made, in light of the circumstances under which they were made, not misleading; or
(Section 17(a)(3) of the Securities Act of 1933) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.”
Section 5(a) of the Securities Act of 1933 – “Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly –

(1) to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or

(2) to carry or case to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale.”

Section 5(c ) of the Securities Act of 1933 – “it shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security, or while the registration statement is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under section 8.”
Section 15(a) of the Securities Exchange Act of 1934 – “(1) It shall be unlawful for any broker or dealer which is either a person other than a natural person or a natural person not associated with a broker or dealer which is a person other than a natural person (other than such a broker or dealer whose business is exclusively intrastate and who does not make use of any facility of a national securities exchange) to make use of the mails or any means or instrumentality of interstate commerce to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security (other than an exempted security or commercial paper, bankers' acceptances, or commercial bills) unless such broker or dealer is registered in accordance with subsection (b) of this section.

(2) The Commission, by rule or order, as it deems consistent with the public interest and the protection of investors, may conditionally or unconditionally exempt from paragraph
(1) of this sub-section any broker or dealer or class of brokers or dealers specified in such rule or order.”

Case Outcome

Settlement

No allegations were admitted or denied by any of the co-founders as well as Rari Capital. Judgement was passed as follows:

Co-Founder Jack Lipstone

Prohibited any future violations of the Securities Act (Sections 17(a)(2) and 17(a)(3) and the Securities Exchange Act (Section 15(a)).
Barred for a period of five years from serving as a director or officer of a public company.
Banned for five years from, except for his own personal account, from the purchase, issuance, sale or offer of crypto assets offered and sold as securities.
The payment of disgorgement and prejudgment interest.
Payment of monetary fines and penalties to the amount of $43,199.98.

Co-Founder Jai Bhavhani

Prohibited any future violations of the Securities Act (Sections 17(a)(2) and 17(a)(3) and the Securities Exchange Act (Section 15(a)).
Barred for a period of five years from serving as a director or officer of a public company.
Banned for five years from, except for his own personal account, from the purchase, issuance, sale or offer of crypto assets offered and sold as securities.
The payment of disgorgement and prejudgment interest.
Payment of monetary fines and penalties to the amount of $63,567.51.

Co-Founder David Lucid

Prohibited from any future violations of the Securities Act (Sections 17(a)(3) and the Securities Exchange Act (Section 15(a)).
Barred for a period of five years from serving as a director or officer of a public company.
Banned for five years from, except for his own personal account, from the purchase, issuance, sale or offer of crypto assets offered and sold as securities.
The payment of disgorgement and prejudgment interest.
Payment of monetary fines and penalties to the amount of $45,208.92.

Rari Capital

Permanently barred from future violations of the Securities Act (Sections 5(a), 5(c) 17(a)(2) and 17(a)(3)) and the Securities Exchange Act (Section 15(a))
Prohibited from purchase, issuance, offer or sale of any securities.

Implications

The misrepresentation caused by Rari Capital had a tremendous negative influence on its client base, as they remained uninformed of the true profitability of their portfolio products. The envisioned product was not delivered.
Apart from this, they also implemented hidden fees which further contributed to significant losses for the investors.
This was also further compounded by the accusation of engaging in unregistered broker activities. The three co-founders were implicated in the selling of interests in the Rari Governance Token (RGT) and the platform's pools.

Broader Implications

For the Fintech Industry

Rari Capital operates as a DeFi platform. According to this, they were able to bypass a certain level of regulatory scrutiny. This allowed investors a means of investing without the regular use of intermediaries or brokerage firms. These providers were seen as autonomous and decentralized.

After the judgment, the SEC has decided to follow suit with regulations in both the regular investment and cryptocurrency environments. Even though an investment platform is held out as DeFi, it will still entail the same scrutiny, especially when there is a distinct possibility of regulatory violations.

Regulatory Trends

The SEC fiercely regulates investment platforms, and crypto products have joined the ranks. These trends are implemented to safeguard investors, whether they utilize brokerage firms or companies that work on the DeFi system. These processes prohibit companies or investment platforms from violating laws and regulations.

Key Takeaways

Lessons Learned

Investor scrutiny is an important consideration when any type of financial decision is to be made.
The SEC aims to regulate and monitor all activity from standard brokerage firms to companies practicing DeFi methodology.
Although not so new to the market, potential investors still have a lot to learn about the crypto industry. making any type of financial decision.

References & Resources

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Case Study: SEC v. Rari Capital Inc et al

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