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On July 31st, the U.S. Securities and Exchange Commission (SEC) released a press release with a charge against Richard Heart, Hex, PulseChain, and PulseX for conducting unregistered offerings of crypto asset securities that raised more than $1 billion in crypto assets from investors. It also alleges that Richard Heart and PulseChain committed fraud by misappropriating at least $12 million of offering proceeds. The Commission filed a complaint in U.S. District Court for the Eastern District of New York. The defendants didn’t come forward with a statement to answer the accusations. Here we break down the case, make the precisations, and give our opinion on the case.
The background
The documents relevant to this case are
The press release published by the SEC
The Complaint
The Securities Act of 1933
The SEC alleges that Richard Heart, Hex, PulseChain, and PulseX violated the registration provisions of Section 5 of the Securities Act of 1933. The complaint also alleges that Heart and PulseChain violated the antifraud provisions of the federal securities laws. The complaint seeks injunctive relief, disgorgement of ill-gotten gains plus prejudgment interest, penalties, and other equitable relief.
Conducting unregistered crypto asset security offerings
According to the documents, Heart was running an unregistered security offering for HEX when he was the only one to promote it in his live streams and on several online platforms before he launched HEX. In so doing, Heart and Hex purportedly created a reasonable expectation of profits, independent of any effort by investors. It then states that neither Heart nor Hex have ever registered Hex tokens or the Hex Offering with the Commission.
The Commission accuses Heart of making false statements that his offerings were not securities offerings. “Although Heart frequently made superficial disclaimers about the status of his offerings under the U.S. securities laws, the economic reality of these offerings—and his promotions of the offerings—were contrary to these disclaimers,” writes the court document. It states also that neither Heart nor PulseChain have registered the PulseChain offering with the Commission.
Funds misappropriation
In the case brought forward by the SEC, Heart is accused of misappropriating $12 million of funds from PulseChain investors. During the PulseChain Sacrifice Period, more than $354 million of crypto assets were sent to the sacrifice address. The SEC finds that Heart transferred or directed the transfer of approximately $217 million in PulseChain offering proceeds, consisting of various crypto assets (ETH, DAI, USDC, and Tether), from the PulseChain SA to another address.
On January 26, 2022, after the official closing of the PulseChain Sacrifice, more than $26.5 million of Tether was transferred from the address in 22 back-and-forth transactions, resulting in approximately $26 million in ETH being deposited to the address. The SEC finds that $12 million has been spent by Richard Heart to purchase luxury goods and a 555-carat black diamond known as ‘The Enigma’. The value of the misappropriation is estimated at $12 million.
Fraud in connection with the sale of the security
The SEC also claims that Heart recycled sacrifice funds to surreptitiously gain control of more Hex tokens while giving the false impression of significant trading volumes and demand for Hex by using their own funds.
The Howey test
The SEC acknowledges that Heart is familiar with the U.S. securities laws and the test (established in SEC v. W.J. Howey Co., 328 U.S. 293 (1946)) for determining what is and is not a security. Based on this test, it determines if something is a security or not. It brought the case because it considers Hex, PulseChain, and PulseX offerings to be unregistered securities offerings.
It must be specified that HEX, PulseChain, and PulseX are not “alter-ego entities” of Richard Heart, as it’s written in the complaint. HEX, PulseChain, and PulseX are decentralized, P2P protocols; however, the SEC calls HEX, PulseChain, and PulseX Richard Heart’s “alter-egos” and calls them “defendants”. A case can’t be brought against a decentralised protocol that can’t defend itself.
To our knowledge, Richard Heart did not offer any security assets because they don’t have a semblance of securities. HEX, PulseChain, or PLSX don’t give purchasers any voting rights, and more importantly, they don’t give them the right to a share in the profits of any single entity. HEX, PLS, and PLSX holders can’t decide on the composition of the members of the board of directors of any entity. In other words, it was never an investment in any single entity.
Moreover, Richard Heart made it very clear that no one should have any expectations from him or anyone else. In the case of PulseChain and PulseX, he repeated many times that the sacrifice wasn’t an investment and that PLS or PLSX have no value. The buyers knew that what they were sacrificing for was freedom of speech and freedom of movement. In the document, the SEC acknowledges that fact:
“Heart frequently claimed that an investment in PulseChain was linked to free speech, for example, stating on July 21, 2021, that, “you believe free speech is a protected human right and blockchains are speech, and you’re sacrificing to prove that you believe that.”
It must be said that Richard Heart was never the sole promoter of any of these assets, and that he often said not to expect any type of work from him.
“Always remember that you must have no expectation of profit from the work of others. Especially me. I do not work for you. I have never worked for you. I will never work for you. If you want good things to happen, you must make them happen yourself. Always and forever. Get to work,” said Richard Heart on one of many occasions.
This clarification about something that is or isn’t a security is essential in establishing the jurisdiction under which the defendants fall. Richard Heart, HEX, PulseChain, and PulseX aren’t securities and don’t fall under the jurisdiction of the SEC.
The word “SALE” is crucial to knowing if something was sold as a security asset. The Securities Act of 1933 (“Securities Act”) defines the word “sale” as follows:
“The term ‘‘sale’’ or ‘‘sell’’ shall include every contract of sale or disposition of a security or interest in a security, for value.”
The word “VALUE” is very important here because none of the assets had any initial value and didn’t yet exist. There was no product, and what was being offered was merely an idea. The ideas have no value until they’re realised. There was no sale for nothing in value. In the case of HEX, people were interacting with an immutable smart contract with no administrative keys, and the contract gave them some tokens that, at the beginning, had zero value. In the case of PulseChain and PulseX, they sacrificed their funds for freedom of speech and movement. To classify something as an investment, there must be an initial value, a principle well-established in securities law.
Richard Heart, HEX, PulseChain, and PulseX had no reason to register with the Commission because they weren’t offering securities.
The SEC built its case based on the presumed obligation to register the offerings with the Commission; however, the same Securities Act from 1933 states that there’s no such obligation.
According to Section 6(a) of the Securities Act,
“Any security may be registered with the Commission under the terms and conditions hereinafter provided.”
“MAY BE” is the most important keyword here. The use of this word suggests that no one of the defendants had any obligation to register with the Commission.
In the Securities Act, there’s also no mention of any obligation to ask the Commission for an exemption from registration.
It must also be brought forward that the SEC claims jurisdiction over Richard Heart and his “alter-egos” based on the fact that “the offering” venue was in New York District solely “because many of the crypto asset transactions described herein took place on Uniswap, a so-called decentralized crypto asset trading platform whose developers are headquartered in Brooklyn. Heart specifically designed PulseX as a fork of Uniswap. Additionally, at least one investor of PulseChain and PulseX resides in this District.”
The SEC built the case citing sections of the Securities Act that concern ‘interstate communication’, and what it means is that the blockcahin and the Uniswap protocol headquartered in New York, allegedly give them the jurisdiction to intervene to protect the investors. The people sacrificed funds for the very purpose of freedom of speech and movement, and when they transact on-chain, they exercise these rights. Stripping people of their rights is against the law.
The charges come in the wake of the much expected documentary The Highest of Stakes about Richard Heart that is going to be screened in theaters from August 4th.
