ICO and Cryptocurrency Enforcement UpdateSeptember 11, 2018, was a big day for Initial Coin Offering (ICO) and crypto-related enforcement activity. In the Eastern District of New York, Judge Raymond Dearie issued an order neglecting to dismiss an indictment against Maksim Zaslavskiy for securities fraud relating to Zaslavisky’s involvement with an ICO for “REcoin” and another referred to as “Diamond.” This case originated with a civil complaint filed almost a year ago in September 2017, which was stayed pending the criminal case filed in January 2018. Meanwhile, FINRA filed a complaint against Timothy Ayre for “attempt[ing] to attract public investment in his worthless public company, ‘Rocky Mountain Ayre,’” which purportedly touted “the first minable coin backed by marketable securities.” And rounding it out, the SEC issued back-to-back orders regarding the resolution of enforcement actions against TokenLot LLC and Crypto Asset Management LP. The following is a brief summary of each of these developments.

Zaslavskiy – 17CR147 (E.D.N.Y.)

Summary: The defendant was indicted for securities fraud and conspiracy to commit securities fraud in relation to both REcoin and Diamond. Defendant brought a motion to dismiss alleging that REcoin and Diamond did not involve securities and that the securities laws are unconstitutionally vague as applied.

Detail: REcoin was purportedly a cryptocurrency backed by real estate holdings, and Diamond was purportedly backed by diamonds. The court’s order contained two separate analyses relating to the defendant’s conduct, with the court noting that the “Indictment charges a straightforward scam.” This characterization presumably relates to the allegation that despite the names and representations, defendant never purchased any real estate or diamonds to back the purported cryptocurrencies. The court first analyzed whether a reasonable jury could find that REcoin and Diamond were investment contracts. In concluding yes, the court was careful to note that the ultimate question of whether REcoin and Diamond were investment contracts was a fact-specific question left to the ultimate fact-finder. Nevertheless, the court analyzed them with the Howey analysis (see Howey, 328 U.S.  293 (1946)). The court found that a reasonable jury could conclude for both REcoin and Diamond that (1) investors invested money, (2) in a common enterprise, and (3) the investors expected profits solely from the managerial efforts of defendant and his co-conspirators.

A second analysis focused on the question of whether U.S. securities laws are unconstitutionally vague as applied to defendant’s conduct. The court notes that the defendant attempted to frame the question as whether the laws were vague when applied to cryptocurrencies, but the court declined to opine so broadly, limiting its analysis to defendants’ conduct without apparently reaching the question of whether REcoin or Diamond were properly classified as cryptocurrencies. In its analysis the dourt found that the defendant failed to demonstrate that a person of ordinary intelligence would not have had sufficient notice that the charged conduct was proscribed. This is perhaps the most interesting aspect of the ruling as it cites Howey as making “it reasonably clear at the relevant time that [the charged] conduct was criminal.” In supporting that conclusion the court cited established case law delineating the meaning of “investment contract.” However, the court also noted some guidance relating to cryptocurrency, citing an SEC Report from late July 2017, a Wall Street Journal article from January 2018, and a public SEC statement from December 2017. Defendant’s purportedly criminal conduct started in January 2017 and ended in October 2017, a few months after the SEC report and before the other materials cited. Also, the quote from the January 2018 Wall Street Journal article that the court includes in a parenthetical merely says “some products that are labeled as virtual currencies have characteristics that make them securities.” The mentions of cryptocurrency leave some room for additional guidance as it is unclear if the court would view REcoin or Diamond as improperly labeled cryptocurrencies, or whether they were properly labeled cryptocurrencies and nevertheless securities. Instead, the court seems to consider the question of whether REcoin or Diamond were properly labeled cryptocurrencies as moot because they were schemes, as alleged, which “fall within the ordinary concept of a security.”

Conclusion: The court denied the motion to dismiss, and the case will proceed to trial.

FINRA – Timothy Tilton Ayre (CRD No. 2091556)

Summary: According to the complaint, Ayre made material omissions and false statements regarding his “worthless public company, Rocky Mountain Ayre, Inc.” (RMTN) in violation of the Exchange Act and FINRA Rule 2020. Ayre subsequently is alleged to have acquired rights to a digital token “HempCoin” and packaged it as a security offering. FINRA further alleges he did not file a registration with the SEC, and no sales were exempt from registration. He also is alleged to have sold convertible debt in RMTN without registering the sale. These offers and sales of unregistered securities violated the Securities Act and FINRA Rule 2010 according to the allegation. FINRA claims jurisdiction over Ayre due to his prior registration as a broker-dealer.

Detail: Ayre’s case has some interesting aspects as outlined in the following allegations from the complaint. RMTN was traded over the counter and quoted on OTCM’s Pink Market. RMTN was a rebrand of Ayre’s company ATI, which was a holding company that owned a bistro at the time of the change.  The complaint cites the HempCoin website and the statement “Hemp coin is the First Minable Coin Backed by Marketable Securities,” saying it “made clear that the cryptocurrency was a security.” The “Marketable Securities” referred to in the HempCoin statement are shares in “RMTN,” and presumably the conclusion in the statement that HempCoin was a security is predicated on Ayre saying it was “backed” by RMTN. This is echoed in a later section relating to the cause of action for unlawful sales of an unregistered security, where the complaint affirmatively states that “Ayre created a security when he purchased the rights to HempCoin and ‘backed’ the cryptocurrency with shares of RMTN. . . .”  The complaint also describes a litany of improper actions purportedly taken by Ayer unrelated to whether HempCoin is a security. Ayer is alleged to have made material misstatements and omissions in public filings about RMTN, including misstatements about the business itself (that it was acquiring “fast-growing food and hospitality and, manufacturing and retail businesses”), failure to disclose the terms of the HempCoin Asset Purchase Agreement, and inflating the company’s disclosed assets.

Relief Requested: The complaint seeks a finding that the respondent willfully violated the Exchange Act in making material misrepresentations and omissions, violated FINRA Rule 2010 with negligent misrepresentations, and violated the Securities Act for the offer and sale of unregistered securities and for making private security transactions.

SEC – TokenLot LLC (33-10543)

Summary: Respondents acted as unregistered broker-dealers by operating a website allowing investors to buy digital tokens such as Bitcoin, Ether, and others (secondary sales), and by facilitating investment in nine ICOs.

Resolution: Respondents consent to cease-and-desist, agree to “develop and execute a plan to refund ICO’s proceeds,” “refund[] investors’ payments for certain secondary market sales,” pay approximately $500,000 to the SEC in disgorgement, and are barred from association with any broker, dealer, etc.

SEC – Crypto Asset Management, LP (CAM) (33-10544)

Summary: Respondents formed CAM for the purpose of managing Crypto Asset Fund, LLC (CAF), a pooled investment vehicle investing in digital assets. CAM violated the Securities Act through unregistered sales of securities through interstate commerce, unregistered sale of interest in an investment company, and obtaining money by means of untrue statement of material fact or omission. The latter was predicated on CAM’s statement that CAF was the “first regulated crypto asset fund in the United States.” CAM remediated by making a rescission offering, disclosing prior misstatements, and began offering securities pursuant to Regulation D Rule 506(c) exemption from registration.

Resolution: Respondents were censured and order to pay a penalty in the amount of $200,000 to the SEC.