Significant legal and enforcement developments in the cryptocurrency space


Last week saw major developments in the cryptocurrency space with two new regulatory actions and a significant and long-awaited decision in a criminal fraud action on securities relating to an initial coin offering.

Specifically, in In the matter of TokenLot, LLC, and others Admin. Proc. No. 3-18739 (11 September 2018) and In the Matter of Crypto Asset Management, LP and Timothy Enneking Admin. Proc. No. 3-18740 (11 September 2018), the SEC has announced agreements with two digital security companies that are considered to operate as unregistered broker-dealers. In United States against Zaslavskiy n. 17-CR-0647, ECF n. 37 (EDNY 11 September 2018), Judge Raymond J. Dearie denied the defendant's motion to reject the indictment and consented to the DOJ that initial money offerings ("ICOs") conducted by the defendant companies could constitute contracts investment under the Federal Securities Law.

United States v. Zaslavskiy

In U.S. v. Zaslavskiy the government accused Maksim Zaslavskiy of conspiracy to commit fraud in securities and two counts of fraud on securities. The allegations refer to two ICOs conducted by the companies of Zaslavskiy, REcoin and Diamond. According to Indictment, REcoin and Diamond, they offered investors the opportunity to purchase "blockchain virtual currency" or "cryptocurrency" supported by real estate investments or investment in diamonds, respectively. The government claimed that, in reality, REcoin and Diamond did not issue digital goods, tokens or coins and did not invest in real estate or diamonds. As described by Judge Dearie: "Stripped of the jargon of the 21st century … the charged accusation charges a simple scam, full of the common characteristics of many financial frauds."

In his dismissal motion, Zaslavskiy contested (1) whether the federal securities law applied to "cryptocurrencies", (2) whether the specific offers of REcoin and Diamond were offered of securities and (3) if the application of the federal laws on cryptocurrency securities made the laws on titles null and vague. The Court rejected all these challenges

First the Court refused to apply a broad exemption under federal securities laws for all so-called cryptocurrencies and digital coins and tokens. While "currencies" are excluded from federal securities law under the Exchange Act and the Securities Act, the Court found that the mere reference to a product or an asset such as "cryptocurrency" was not clearly sufficient to exclude it from all federal securities regulations. . Instead, the Court focused on "the content of the instruments in question, on the purposes to be served and on the factual approach as a whole." Order in 8 (citing Marine Bank v. Weaver 455 United States 551, 560 n.11 (1982)). In particular, the Court did not address the broader issue if real cryptocurrencies, such as Bitcoin, would be exempt from federal securities laws.

According to addressing the specific facts in the case of Zaslavskiy, the Court held that the tokens, coins and cryptocurrencies offered by REcoin and Diamond could constitute titles in terms of content, purpose and "factual approach as a whole", reasoning on the fact that they are similar to the investment contracts that the Supreme Court held in SEC v. Howey 328 US 293 (1946), to fall within the jurisdiction of the federal securities law. According to Howey a financial transaction is an "investment contract" if "a person invests his money in a joint venture and is expected to expect profits exclusively from the efforts of the promoter or third parties". case, investors paid to invest in RECOin and Diamond ICOs and high returns were promised by putting together their investment in diamonds and real estate, which had to be selected and managed by Zaslavksiy and "an expert team of brokers, lawyers and developers". a 3. The Court found that a reasonable fact-finder could determine that these were indeed investment contracts, and therefore denied this aspect of the motion of the host.

Lastly the Court held that the application of federal securities laws to cryptocurrencies does not make those laws unconstitutionally vague. Vacuum tests for vagueness involve a two-part test: [a court] must first determine whether the statute offers the ordinary person a reasonable opportunity to know what is prohibited and then consider whether the law provides explicit standards for those who apply it. " Farrell v. Burke . 449 F.3d 470, 486, 495 (2d Cir. 2006) (internal quotation marks and omitted quotations). In rejecting the defense's argument, the Court cited a well-defined precedent in which the courts underline that federal securities laws must be interpreted in a flexible way and a broad jurisprudence post- Howey concerning the definition of "investment contract". As Judge Dearie said, the alleged conduct "falls within the core of the statute ban" and found Zaslavskiy's void for vague arguments "clearly insufficient to bypass the legal and criminal enforcement of securities laws". Order at 21.

SEC enforcement actions: in the matter of TokenLot, LLC, et al. and in the matter of Crypto Asset Management, LP and Timothy Enneking

First in In the matter of TokenLot, LLC and others the SEC charged to TokenLot LLC and its principals, Lenny Kugel and Eli L. Lewitt, operating as unregistered broker-dealers. TokenLot operated a website that marketed and sold digital tokens to investors in connection with ICO and secondary market trading, even though TokenLot, Kugel and Lewitt were not registered as broker-dealers. The SEC Order assumes that the activities of TokenLot in the marketing and sales of ICO and in facilitating the secondary trading of digital tokens fall within the scope of federal securities laws. Tokens, also known as coins, offered by TokenLot and other similar platforms are issued by virtual organizations that run on a distributed ledger or blockchain and are used by companies to finance digital product development. Holders of tokens or coins can then use them in the digital product or sell them for profit

TokenLot and its owners have resolved the charges against them without admitting or denying the conclusions of the SEC, and have agreed to pay $ 568,929 in exchange disbursement, detrimental interests, and penalties.

According to in In the matter of Crypto Asset Management, LP and Timothy Enneking the SEC claimed that Crypto Asset Management, LP ("CAM") and its principal, Timothy Enneking, operated as an unregistered investment company and produced significant errors in violation of federal securities law. According to the SEC's order, CAM ran a collective investment vehicle that invested in digital assets. Although the SEC did not specify what type of digital assets were involved, it stated that they constituted "investment securities" under the Investment Company Act and "securities" under the Securities Act. In addition, CAM allegedly marketed as the "first regulated regulatory capital in the United States", despite not filing a registration statement with the SEC.

According to the SEC, CAM has violated the Securities Act by making significant errors to investors when you offer and sell digital assets. CAM and Enneking entered the order without admitting or denying any of the conclusions and agreed to pay $ 200,000 in penalties.

The recent enforcement actions of the SEC underline the growing attention of prosecutors and regulators on increasing cryptocurrency, and the decision of Judge Dearie in Zaslavskiy is a significant victory for prosecutors in a decision widely anticipated. Although clearly limited to the facts, the decision will certainly serve as a powerful precedent for SEC and DOJ in future disputes concerning the application of the securities law to the cryptocurrency space.

In the matter of Crypto Asset Management, LP and Timothy Enneking

In the matter of TokenLot, LLC

United States v. Zaslavskiy

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