Is that a cryptocurrency or securities fraud?
Posted on 12/20/2018 at 02:30 PM by John Lande
Anyone who thinks cryptocurrencies are still the “wild wild west” hasn’t been paying attention to what federal prosecutors and regulators have been up to lately. Earlier this year, the United States Department of Justice (“DOJ”) charged Maksim Zalsavskiy with securities fraud and conspiracy for activities related to two initial coin offerings (“ICOs”). Maksim moved to dismiss the three count indictment by arguing that federal securities laws don’t apply to cryptocurrencies, and the securities laws are too vague to be enforceable. Unsurprisingly, a court ruled earlier this year that the securities laws do apply to ICOs, and the securities laws are not too vague.
Maksim’s scheme centered on a plan to sell REcoin, which was supposed to be backed by real estate investments. However, REcoin was never backed by any real estate, never hired any professionals to help develop it, and had not sold 2.8 million tokens as advertised on its website. Maksim convinced 1,000 investors to purchase REcoin.
Maksim then offered investors in REcoin an opportunity to invest in Diamond, which was supposed to be a cryptocurrency backed by diamonds. As with REcoin, there were no diamonds, and no real-world assets backing the currency.
The bulk of the Court’s analysis focused on whether REcoin and Diamond are securities. Federal law defines securities to include “investment contracts.” An “investment contract” is any contract, transaction, or scheme whereby a person  invests his money  in a common enterprise and  is led to expect profits solely from the efforts of the promoter or third party.
First, there was no doubt that REcoin and Diamond involved investor funds. The Court also found that REcoin and Diamond satisfied the second requirement, because the purpose of both products was to pool investor funds in order to purchase real world assets—real estate and diamonds. Investors would then receive distributions based on the number of tokens they owned. Finally, the Court concluded that investors were led to believe that Maksim’s efforts would lead to profits.
This case does not mean that DOJ is coming after Bitcoin, or other more mainstream cryptocurrencies. REcoin and Diamond were run-of-the mill fraud schemes masquerading as ICOs. Unlike some other cryptocurrencies, these two products more closely resemble stock in a traditional company. However, it was also easy for Maksim to dress his fraud up in 21st Century jargon in order to appeal to anxious investors looking to cash in on the cryptocurrency craze. This case highlights the need for investor scrutiny and due diligence over products claiming to be cryptocurrencies. A study earlier this year suggests that over half of ICOs are fraudulent, but nevertheless generated $1.34 billion for fraudsters in 2017 alone.
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