AUS: Court "relieves" crypto company of liability for pecuniary penalty.

News Desk

It's an odd use of language but we should, by now, be getting used to that from Australia. A court has decided not to impose a fiscal penalty on a crypto company for offering an unregistered investment scheme despite a finding that it did, in fact, make such an offer. The Court's expression of its reasoning is long and complex but the actual reasoning is remarkably simple. Its decision not to impose a penalty is described as "relieving it of that liability" even though the order that the company contravened relevant legislation stands. And it all starts with crypto-lending, a concept that the court found isn't what those promoting it say it is.

Jackman J, in the case of Australian Securities and Investments Commission v Web3 Ventures Pty Ltd [2024] FCA 64 found that Web 3 Ventures, trading as Block Earner produced two products, one known as "Earner" and one known as "Access".
The Principal Judgment is a model of clarity and is one of the best primers on crypto and some aspects of the law, regulation and use of them yet seen.The Penalty Judgment is complex by reason of the many and varied arguments put forward and because of the constraints of legislative language that the judge has to work under.

The Court found as follows:

The defendant has contravened s 911A(1) and (5B) of the Corporations Act 2001 (Commonwealth)
1. By carrying on a financial services business without holding an Australian financial services licence covering the provision of financial services with respect to the “Earner” product.

2. The defendant has contravened s 601ED (5) and (8) of the Corporations Act 2001 (Commonwealth) by operating an unregistered managed investment scheme with respect to the “Earner” product.

3. The proceedings be dismissed insofar as they relate to the “Access” product

Block Earner also operates a digital currency exchange which is registered with the Australian Transaction Reports and Analysis Centre (AUSTRAC), that allows users to exchange Australian dollars (AUD) into cryptocurrencies.

The principal judgment frames the issue thus:

"The disputes between the parties concern whether the Earner and Access products are “financial products”. ASIC contends that the Earner and Access products are financial productsbecause each product is one or more of a managed investment scheme, a facility by which a person makes a financial investment, or a derivative. If Earner or Access are financial products, then it is common ground that Block Earner has contravened s 911A of the Act by carrying on a financial services business without holding an Australian Financial Services Licence (AFSL). Further, if either Earner or Access is a managed investment scheme, then it is common ground that Block Earner has contravened s 601ED(5) of the Act by operating an unregistered managed investment scheme."

There is an interesting statement in which ASIC makes a statement then effectively takes it back "For the purposes of this proceeding, ASIC does not contend that USDC, PAXG, BTC and ETH (i.e. crypto currencies) are financial products within the meaning of the Act."

Having decided that he did not need to decide whether cryptocurrencies are "property" in law, the Judge said "the concept of “lending” cryptocurrency is a misnomer. If one were to assume that cryptocurrency is a species of property, the word “lend” in connection with cryptocurrency would seem akin to its use in securities lending, whereby securities are actually transferred outright by way of sale and purchase from the “lender” to the “borrower”, with the borrower being contractually obliged to redeliver to the lender at a later time securities which are equivalent in number and type...n reality, however, the so-called “lending” of cryptocurrency merely involves the conferral of an ability to control."

Basically, the "Earner" product offered customers a return on deposits with the company. That would have been the simple way to describe it but no one in Crypto seems willing to describe anything is a simple way. So, as the judge put it, "The Earner product allowed customers to lend to Block Earner and receive a fixed rate return over the term of the loan. In the usual case, Block Earner converted the customer’s Australian dollars (AUD) into a cryptocurrency nominated by the customer at the commencement of the loan, and then at the end of the loan, the customer was entitled to a return of AUD calculated by reference to the price of the relevant cryptocurrency, plus the fixed rate return. "

So, in summary, customers deposited with Block Earner fiat currency for a fixed term. Block Earner used that fiat currency to buy crypto-currencies and it held them during the term. At the end of the term, the crypto was sold and a return paid to the customer based upon the performance of the cryptocurrencies plus a fixed rate of return.

What could possibly go wrong? Ask Genesis (but we digress).

After considerable analysis, the Judge concluded that "Earner" was indeed a managed investment product and should have been registered.

The "Access" product did not require the making of a deposit with Block Earner and Block Earner did not manage the assets. Indeed, the individual customer managed his own assets and Block Earner's involvement was (to over-simplify it) to act in the purchase of assets and to provide a management platform that the customer used. For this reason Access was not a managed investment product.

The judgment really is worth spending an hour or two reading, making notes and remembering.

But then came the "penalty" phase.

"The effect of relief is not to remove the breach... it is not relief from the finding of contravention itself but rather relief from liability resulting from orders following a finding of contravention."

The term "relief" is actually a very old term in the law of Equity which means it's about 1000 years old and it doesn't mean what it at first appears, to a 21st century reader, to mean. A plaintiff or petitioner "begs relief" which means he asks the court to right a wrong.

If this were a criminal prosecution, what would be happening is that the company would be saying "We accept a guilty verdict and this is our mitigation which we think is sufficiently strong that the conviction is recorded but no penalty is applied."

As regulatory action of the type brought in this case are civil actions, the company is making a similar argument but without the reference to conviction. In effect, it is saying "in all the circumstances of the case, we should be excused from suffering a penalty." Spoiler alert, the judge agreed.

Block Earner had an "Enterprise Risk Management Framework" which included the following;

"Block earner has no appetite for breaches in laws and regulations. Whilst recognising that regulatory non-compliance cannot be entirely avoided, Block Earner strives to reduce this to an absolute minimum."

"In this case, I am satisfied that Block Earner acted honestly", said the judge. It was accepted that [Charlie] Karaboga, at the time "Earner" was launched considered whether an Australian Financial Services Licence was required and formed the view that it was not a regulated financial product and a licence was, not, therefore, required. This decision was reached with the head of compliance and it was decided that Earner was not intended to be nor understood to be a regulated product.

Moreover, "Block earner submits that the contraventions were breaches resulting from a misapplication of the technical definitions of managed investment scheme and financial products in the Act." The court found that Block Earner acted in accordance with its interpretation of the Access product. ASIC accepted that Block Earner "acted without any deceit or conscious impropriety and without any intent to gain an improper benefit or advantage.

ASIC's Hail Mary

But ASIC asked the Court to find that Block Earner's conduct was so unreasonable "so as to constitute carelessness or imprudence of such as degree as to permit the Court to find that Block Earner did not meet the statutory requirement of acting honestly." It based its argument on a false accusation that Block Earner did not obtain relevant legal advice, an accusation that it later retracted.

The judge was dismissive of ASIC's argument saying "I do not regard Block Earner as having been careless or imprudent, let alone guilty of carelessness or imprudence of such a degree as to demonstrate that no genuine attempt at all had been made to carry out the requirements of the Act or the general law." He goes on to give ASIC a bit of a kicking, albeit in the polite language of a courtroom.

No customer suffered any loss or damage as a result of the breach. Block Earner voluntarily discontinued the product when questions were raised and returned to all customers all of the crypto held in the scheme. But there was a risk, ASIC argued, and the judge agreed: it was possible that a shortfall would occur and the company, as a responsible entity of a managed investment scheme, would not be able to maintain its minimum regulatory requirement of AUD10 million in net tangible assets.

Block Earner argued that the contraventions arose in an uncertain regulatory environment where government bodies were unsure as to the extent to which the financial product regime in the Act applied to cryptoasset service providers. The company produced several conflicting documents issued by various government bodies.

It is here opined that this arose because regulators choose to regulate "products" rather than to regulate activity.

Block Earner also raised with the Court the publicity that ASIC generated, and reports based upon it, which created an impression, the company said, that Block Earner was (our words not theirs) a risky company. That, Mr Karaboga said and it was not challenged by ASIC, that the reports "will have devastating business and reputational consequences for the services that Block Earner continues to offer.. which can be particularly severe for new companies like Block Earner which do not have significant cash reserves or are dependent on future fundraising. ASIC disagreed. The judge agreed with the company.

The full judgment is long and complex and contains much of relevance to compliance officers and companies across the financial services spectrum. It has far wider application than in only the crypto sector.

Further reading:

Principal judgment:…
Penalty judgment:…