Federal Judge Applies Long-Established Securities Law to ICOs

Does a decades-old securities law apply to an initial coin offering (ICO)? In a case that represents the first time securities laws have been applied to cryptocurrencies, a district judge says it may.

On September 11, 2018, in a district courthouse in Brooklyn, New York, Judge Raymond Dearie ruled that two ICOs were securities, based on established laws that govern the financial instruments. His decision does not imply that all ICOs are securities, but that simply calling a token a “currency” does not preclude it from being classified as a security.

Turning back a few pages, in October 2017, businessman Maksim Zaslavskiy was accused of misleading investors in two separate ICOs. He raised about $300,000 in a cryptocurrency called REcoin, which he claimed was backed by real estate, and a cryptocurrency called Diamond, which he claimed was backed by diamonds. In truth, no real estate nor diamonds backed either of the coins, and Zaslavskiy was charged in a criminal complaint with conspiracy and two counts of securities fraud — charges that carry up to five years in jail and a fine.

Zaslavskiy moved to have the charges dismissed. He argued that his ICOs were not securities, but “the exchange of one currency for another,” and that securities laws are too “unconstitutionally vague” to be applied to his case.

Cornell law professor Robert Hockett calls the insistence that the laws are vague a “Hail Mary.” “It is a fallback argument,” he told Bitcoin Magazine. “At first the defendant says the law is clear in that it clearly does not apply, but then he effectively says, ‘I have no way of knowing what I can do because the law is unclear.’”

Judge Dearie found the laws clear enough. He pointed out that laws are meant to be interpreted flexibly. He then went on to determine that the two ICOs in question were “investment contracts” by applying the Securities Exchange Act of 1934, one of the most important pieces of legislation governing securities, and the Howey Test, a checklist regulators use to determine if an asset is a security.

Specifically, the Howey Test determines that a transaction represents an investment contract if “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” According to case documents, Judge Dearie found that REcoin and Diamond investors “undoubtedly expected to receive profits in their investments.”

In his arguments, Judge Dearie also referenced the DAO Report, an investigative report issued by the U.S. Securities and Exchange Commission (SEC) in July 2017 claiming that tokens sold on an Ethereum-based investment fund were securities, and public statements made by SEC Chairman Jay Clayton on cryptocurrencies and ICOs in December 2017. At that time, Clayton noted that “simply calling something a ‘currency’ or a currency-based product does not mean that it is not a security.”

“Combined with statements the SEC chairman made previously, yesterday’s decision lends further credence to what many of us believe, which is that offered coins will count as investment contracts and hence securities,” said Hockett. “The SEC has made noises that ICOs were securities, but up until now, there has been no official legal ruling declaring they were.”

The case still has to go to trial and, ultimately, it will be up to a jury to decide whether the ICO in question was a security. Still, Hockett said: “I really doubt an appellate court will overturn the district court’s ruling.”

ICOs have been a major source of controversy in the crypto space. So far, about $20 billion has been raised in ICOs, most of that in the last two years. In a talk at MIT in April 2018, Gary Gensler, former chairman of the Commodity and Futures Trading Commission (CFTC), another regulatory body that has weighed in on ICOs, noted “significant noncompliance” with securities laws in the cryptocurrency space. “Many initial coin offerings, probably well over a thousand, many crypto exchanges, probably 100 to 200, are basically operating outside of U.S. law,” he said.

Source
Author: Amy Castor
Image Credit

U.S. Judge Rules That ICOs are Covered by Securities Laws

A U.S. District Judge in Brooklyn has delivered a landmark judgement with far-reaching implications for the initial coin offering (ICO) market. Judge Raymond Dearie of the U.S. District Court Eastern District of New York today ruled that U.S. securities laws cover ICO token sales.

The ruling came in a case against a fraudulent ICO promoter Maksim Zaslavskiy, whom prosecutors are looking to bring up on fraud charges for defrauding investors of more than $300,000 from a scam ICO called REcoin.

REcoin ICO Scam

In Sept. 2017, CCN reported that the SEC charged Zaslavskiy and two of his companies with defrauding investors through a number of ICO scams including REcoin. REcoin was marketed to investors as being backed by real estate and diamond assets which in actual fact did not exist.

In a pioneering ruling, Judge Dearie refused to dismiss the case against Zaslavskiy, whose lawyers earlier pled for dismissal on the basis that the ICOs in question were currencies and not securities, placing them outside the jurisdiction of the SEC Act.

An excerpt from today’s hearing file reads:

“He [Zaslavskiy] argues that the securities laws are  unconstitutionality vague as applied. The Government, meanwhile, asserts that the investments made in REcoin and Diamond were “investment contracts,” and thus “securities,” […] and that these laws are not unconstitutionally vague.”

Judge Dearie’s ruling on this matter was that an ICO is indeed a security for the purposes of federal criminal law, which is what prosecutors have argued since last year.

Implications of Dearie’s Ruling

The SEC claims the REcoin ICO scammed investors out of $300,000.

Dearie has become the first judge to deliver a ruling that places ICOs firmly within the jurisdiction of securities regulators, and this could potentially have important implications for the ICO market by creating a precedent for future cases.

While the CFTC has had some successes tackling fraudulent crypto offerings within its space, the SEC — which has long said that it has jurisdiction over most ICOs — had not yet established this authority in court.

An excerpt from Judge Dearie’s ruling reads:

“Zaslavskiy’s contrary characterizations are plainly insufficient to by pass regulatory and criminal enforcement of the securities laws. Because the indictment is sufficient under the Constitution and the Federal Rules of Criminal Procedure, and because the law under which Zaslavskiy is charged is not unconstitutionally vague as applied, Zaslavskiy’s motion is denied. The case will proceed to trial.”

While the ruling comes as a boost for prosecutors, the it is by no means a final word on the matter. In his comments, Judge Dearie noted that the ultimate decision rests with a jury and that Zaslavskiy’s lawyers can in fact still present the argument contesting the jurisdiction of securities laws to the jury.


Source
Author: David Hundeyin
Front Image Credit