Home ICOs Judge Applies Securities Law to Initial Coin Offering Case

Judge Applies Securities Law to Initial Coin Offering Case


A federal judge has ruled that U.S. securities laws may cover an initial coin offering, handing the government a legal victory in its effort to regulate billions of dollars in cybercurrency offerings much like stocks are.

The ruling came in a criminal case against a man charged with promoting digital currencies backed by investments in real estate and diamonds that prosecutors said didn’t exist. U.S. District Judge Raymond Dearie in Brooklyn, N.Y., said on Sept. 11 that the government can proceed with a case alleging that an initial coin offering is a security for purposes of federal criminal law.

About $18.7 billion has been raised this year by so-called ICOs, according to data compiled by Coinschedule.com. Securities and Exchange Commission Chairman Jay Clayton has said the fundraising method should be regulated, adding that he believes the market has become rife with fraud as it quickly expanded with the popularity of digital currencies and blockchains.

“This ruling affirms the SEC’s position that it has authority over ICOs and that market manipulation and anti-fraud provisions in the law apply,” Peter Henning, a professor at Wayne State University’s law school in Detroit, said in an interview.

The New York case, which prosecutors said was the first criminal prosecution of its kind, involves Maksim Zaslavskiy. The Brooklyn businessman was charged with conspiracy and two counts of securities fraud for his role in defrauding investors in two initial coin offerings. He’d argued that the ICOs at issue weren’t securities but instead currencies. Zaslavskiy also said securities law was too vague to be applied to initial coin offerings.

In his ruling Sept. 11, the judge said it will ultimately be up to the jury to decide whether the ICO at issue was a security, but the allegations in the indictment would support such a finding. The judge’s decision focused on the particulars of Zaslavskiy’s alleged ICOs, and not on other ICO transactions, but if upheld on appeal, the ruling could have broader ramifications.

“Per the indictment, no diamonds or real estate, or any coins, tokens, or currency of any imaginable sort, ever existed — despite promises made to investors to the contrary,” Dearie said in his ruling. “Simply labeling an investment opportunity as a ‘virtual currency’ or ‘cryptocurrency’ does not transform an investment contract — a security — into a currency.”

ICOs are a fundraising mechanism used by blockchain startups that are similar to initial public offerings in equity markets. In an ICO, however, the money is raised before a product is ready for market. A team of developers and designers offer digital assets for sale that will be needed later on to access the software that’s being developed. In theory, if there is demand for that software — say a service like Uber but that is hosted on a decentralized network like the Ethereum blockchain — the coins used to access that service will be in demand and therefore rise in value.

Regulatory Effort

Federal regulators have urged investors to be cautious with ICOs and stepped up efforts to police the market for digital tokens, which companies and individuals have used to raise billions of dollars for projects or ventures. After a record $5.8 billion was raised in June, according to CoinSchedule, the pace has cooled as the prices of Bitcoin and Ether have tumbled.

Clayton has repeatedly said the vast majority of the offerings should be registered and that the coins trade on secondary markets like other securities the SEC regulates. But ICOs have been slow to subject themselves to the agency’s oversight, and just a relatively small number of issuers moving to register. In a January interview, Clayton pledged to sanction more firms “if people don’t change their ways.”

Prosecutors argued that investments offered by Zaslavskiy in the two ICOs — ReCoin Group Foundation and Diamond Reserve Club — were “investment contracts” that were securities under federal securities laws. The judge, who on Sept. 11 rejected the defendant’s request to have the case dismissed, voiced skepticism about the defendant’s arguments that securities laws didn’t apply to him.

“There was no blockchain, no real estate, there were no diamonds,” Dearie told the defense at a hearing to dismiss the case in May. “It just wasn’t there. It’s a gossamer. There’s just nothing to it.“

Mildred Whalen, a lawyer for Zaslavskiy, didn’t immediately return a voicemail message seeking comment. His client has denied wrongdoing. John Marzulli, a spokesman for Brooklyn U.S. Attorney Richard Donoghue, whose office is prosecuting the case, declined to comment. An SEC spokesman also declined to comment.

The case is United States v. Zaslavskiy, E.D.N.Y., No. 1:17-cr-00647, order 9/11/18.

©2018 Bloomberg L.P. All rights reserved. Used with permission

With assistance from Matthew Leising

To contact the reporters on this story: Patricia Hurtado in Federal Court in Manhattan at [email protected]; Ben Bain in Washington at [email protected]

To contact the editors responsible for this story: David Glovin at [email protected]; Steve Stroth

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