I. Overview
February 2023 was an active month for crypto-related enforcement actions. Enforcement agencies brought additional charges as part of the ongoing fallout of FTX. The Securities and Exchange Commission (“SEC”) brought another action against a celebrity for touting tokens, stopped a cryptocurrency-based investment scheme targeting vulnerable individuals, and brought charges against defendants for an alleged multi-billion dollar fraud involving an algorithmic stablecoin. The SEC also issued a settled order regarding cryptocurrency staking, which could have a significant impact on the future of staking services for retail investors.
The Department of Justice (“DOJ”) charged a defendant for an alleged scheme to fraudulently obtain approximately $110 million worth of cryptocurrency, obtained its first guilty plea in an insider trading case related to cryptocurrency markets, identified a scheme involving money laundering of cryptocurrency, and indicted the founders of a decentralized finance cryptocurrency investment platform for running a Ponzi scheme. And finally, the Commodity Futures Trading Commission (“CFTC”) also brought an action alleging that a company and its CEO engaged in a Ponzi-like scheme involving digital assets.
II. Securities and Exchange Commission Crypto Enforcement Actions
A. Emiliano S. Ryn and GexCrypto Corp (February 7, 2023)
In its complaint dated February 7, 2023, the SEC alleges that between October 2017 and July 2018, Emiliano Ryn defrauded 26 investors out of more than $800,000 in a cryptocurrency-based investment scheme primarily targeted at elderly and technologically unsophisticated individuals. In addition to defrauding investors, Ryn was charged with selling unregistered securities. (See Press Release).
According to the SEC, the first part of Ryn’s scheme involved the formation of GexCrypto, purportedly to launch a crypto asset trading platform. Ryn represented to investors the superiority of the GexCrypto trading platform’s technology and its one-of-a-kind customer service. He did this through, among other means, a professionally-produced video available on GexCrypto’s website and other public statements. In reality, however, GexCrypto was never operational, and the descriptions of GexCrypto provided to investors were not based in reality.
The SEC further alleged that, to raise money to support and develop GexCrypto’s trading platform, Ryn, through GexCrypto, conducted an initial coin offering (“ICO”) of “GexCoins.” The ICO was advertised publicly on GexCrypto’s website and social media, and Ryn also promoted it directly to individual investors. Again, in connection with the ICO, Ryn and GexCrypto made misleading statements about GexCrypto’s existing operations and guaranteed outsized returns to investors. And Ryn failed to disclose to investors that the trading platform was nonexistent.
According to the SEC, another part of Ryn’s scheme involved a purported crypto asset mining business in which Ryn would pool investor funds to purchase mining equipment and pay investors returns based upon the amount of crypto assets mined. Ryn promised investors a guaranteed return from the mining business of at least $10,000 per month. However, none of Ryn’s promises materialized; no investment returns were ever paid, and investors lost all of their contributions. When investors began to press Ryn about their promised returns, the SEC alleged that he created and distributed a second worthless digital token to investors, falsely told investors he was in the Philippines to register GexCrypto with the Philippine regulators, and provided two investors with a fraudulent bank statement purportedly showing that payment of their promised distributions was imminent.
The SEC’s complaint charges defendants with violating § 5(a) and § 5(c) of the Securities Act, as well as §17(a) of the Securities Act and § 10(b) of the Exchange Act and Rule 10b-5. Without admitting or denying the allegations, Ryn and GexCrypto consented to a final judgment subject to court approval. Under the final judgment, the defendants would pay, on a joint-and-several basis, a disgorgement of $825,994.37, prejudgment interest of $187,567.87, and a civil money penalty of $1,000,000. The defendants would also be permanently enjoined from violating the charged provisions. The final judgment against Ryn also prevents him from serving as an officer or director of a public company and from participating in the issuance, purchase, offer, or sale of any security.
B. Payward Ventures, Inc. and Payward Trading Ltd. (“Kraken”) (February 9, 2023)
On February 9, 2023, the SEC charged Kraken with failing to register its crypto asset staking-as-a-service program as a securities offering. (See Press Release). According to the SEC’s order, under that program, investors transferred crypto assets to Kraken for staking in exchange for an annual investment return of as much as 21%. Beginning in 2019, Kraken offered and sold its crypto asset “staking services” to the general public, whereby Kraken pooled certain crypto assets transferred by investors and staked them on behalf of those investors.
Staking is a process in which investors lock up – or “stake” – their crypto tokens with a blockchain validator with the goal of being rewarded with new tokens when their staked tokens become part of the process for validating data for the blockchain. In finding the Kraken staking program to involve the issuance of an unregistered investment contract under Howey, the majority of the Commission found it particularly important that when investors provide tokens to staking service providers, they lose control and possession of their tokens and take on risks associated with the platform, and that investors were passive participants who reasonably expect staking service providers to perform all of the efforts necessary to obtain the advertised and promised investment returComplaint
The complaint charged defendants with violating § 5(a) and § 5(c) of the Securities Act. Without admitting or denying the charges, the two Kraken entities agreed to cease offering or selling securities through crypto asset staking services or staking programs and pay $30 million in disgorgement, prejudgment interest, and civil penalties.
SEC Chair Gary Gensler stated that “Whether it’s through staking-as-a-service, lending, or other means, crypto intermediaries, when offering investment contracts in exchange for investors’ tokens, need to provide the proper disclosures and safeguards required by our securities laws.” Chair Gensler further noted that “Today’s action should make clear to the marketplace that staking-as-a-service providers must register and provide full, fair, and truthful disclosure and investor protection.” Contemporaneously with the agency’s announcement of the settled action, Commissioner Hester M. Peirce issued a dissent stating that “using enforcement actions to tell people what the law is in an emerging industry is not an efficient or fair way of regulating.” Commissioner Peirce further made the point that staking services are not uniform, which makes one-off enforcement actions a particularly ineffective way to communicate to the marker what is and is not allowed. Commissioner Peirce’s dissent also noted that staking services raise many questions about which the Commission has offered no guidance, including “whether the staking program as a whole would be registered or whether each token’s staking program would be separately registered, what the important disclosures would be, and what the accounting implications” would be for the staking service provider.
C. Terraform Labs PTE Ltd. and Do Hyeong Kwon (February 16, 2023)
On February 16, 2023, the SEC charged Terrarform Labs PTE LTD and Do Hyeong Kwon “with orchestrating a multi-billion dollar crypto asset securities fraud involving an algorithmic stablecoin and other crypto asset securities.” (See Press Release). The SEC’s complaint alleges that from April 2018 through May 2022, Terraform and its CEO, Kwon, raised billions of dollars from investors by offering and selling an inter-connected suite of crypto asset securities, many in unregistered transactions. One of these alleged crypto asset securities was Terra USD, a self-styled “algorithmic stablecoin” designed to maintain its peg to the U.S. dollar by being interchangeable for LUNA, another of the defendants’ crypto assets.
The SEC’s complaint alleges that Terraform and Kwon repeatedly told investors that a popular Korean electronic mobile payment application called “Chai” employed the Terraform blockchain to process and settle commercial transactions between customers and merchants. However, Chai payments did not use the Terraform blockchain. Rather, Defendants deceptively replicated Chai payments onto the Terraform blockchain in order to make it appear that they were occurring on-chain when, in fact, Chai payments were made through traditional means.
The SEC charges that, in addition, Terraform and Kwon misled investors about the stability of Terra USD. Specifically, the complaint alleges that in May 2021, Terra USD dropped below its $1.00 peg. In response, the defendants secretly discussed with a third party that the third party would purchase a large volume of Terra USD to restore the $1.00 peg. As Terra USD returned to $1.00, Kwon and Terraform publicly and repeatedly stated that the restoration of the $1.00 UST peg was a “triumph of decentralization” and described the Terra USD/LUNA algorithm as “automatically self-heal[ing].” These statements misleadingly omitted the fact that a third party intervened to restore the $1.00 peg. In May 2022, under selling pressure from large Terra USD holders, Terra USD de-pegged from the U.S. dollar and once again fell below $1.00. This time, without the intervention of a third party to save it, the price of Terra USD and LUNA plummeted to nearly zero. This brought down other crypto asset securities in the interconnected Terraform ecosystem and erased over $40 billion in market value.
In addition to alleging that the defendants’ conduct involved the unregistered sale of “investment contracts,” the complaint also alleges that the defendants offered and sold “mAssets,” which the SEC alleges are security-based swaps designed to pay returns by mirroring the price of stocks of US companies. As alleged in the complaint, this conduct constituted the unregistered offer of security-based swaps to ineligible contract participants. As such, the SEC also charged the defendants with violating Securities Act § 5(e), § 17(a); the Exchange Act § 6(l), in addition to the now familiar suite of antifraud and registration charges.
D. Paul Anthony Pierce (February 17, 2023)
Former NBA star Paul Pierce settled an action brought by the SEC alleging that Pierce made material misstatements when touting EMAX (digital tokens offered by EthereumMax, which the SEC concluded are securities) through his Twitter account. (See Press Release).
The Order outlines Pierce’s statements as false and misleading, because Pierce both overstated his position in the digital asset and indicated his intention to hold or increase his position, when in reality he was selling out of his position. The Order also cites Pierce’s failure to disclose that EthereumMax was compensating him for promoting EMAX to his 4 million Twitter followers as the basis for an anti-touting violation. Without admitting or denying the SEC’s findings, Pierce agreed to cease and desist from committing future violations of §17(a)(2) and §17(b) of the Securities Act, pay disgorgement of $244,116 and pre-judgment interest of $15,449, and pay a civil penalty of $1,150,000.
The SEC is looking at cases involving celebrity promoters with increasing frequency as indicated in this recorded Twitter message from Chair Gensler in October 2022 and related action against Kim Kardashian for touting the same EMAX token.
III. U.S. Department of Justice Crypto Enforcement Actions
A. U.S. v. Eisenberg (S.D.N.Y. February 2, 2023)
According to a January 9, 2023 indictment, Avraham Eisenberg allegedly engaged in a scheme to fraudulently obtain approximately $110 million worth of cryptocurrency from the cryptocurrency exchange Mango Markets and its customers. Eisenberg achieved this objective by artificially manipulating the price of MNGO token and certain perpetual futures contracts. (See Press Release).
MNGO token is a so-called “governance” token. “Governance” tokens typically allow token holders to influence the direction of the blockchain project. Mango Markets is a decentralized cryptocurrency exchange that allows investors to, among other things, purchase and borrow cryptocurrencies and cryptocurrency-related financial products. Investors on Mango Markets can buy and sell perpetual futures contracts. When an investor buys or sells a perpetual contract for a particular cryptocurrency, the investor is not buying or selling that cryptocurrency but is, instead, buying or selling exposure to future movements in the value of that cryptocurrency relative to another cryptocurrency.
According to the indictment, Eisenberg used an account that he controlled on Mango Markets to sell a large amount of MNGO perpetual futures contracts and used a separate account on Mango Markets to purchase those same contracts. Eisenberg then made a series of large purchases of MNGO on multiple cryptocurrency exchanges with the objective of artificially increasing the price of MNGO relative to USDC and, in turn, the price of MNGO perpetual futures contracts on Mango Markets. Eisenberg’s manipulative trading caused the price of MNGO perpetual futures contracts on Mango Markets to rise approximately 1300% in approximately 20 minutes. Because Mango Markets allowed investors to borrow and withdraw cryptocurrency based on the value of their assets on the platform, the artificial increase in the value of the MNGO perpetual futures contracts Eisenberg had purchased from himself allowed him to borrow, and then withdraw, approximately $110 million worth of various cryptocurrencies. Those funds came from the deposits of other investors in the Mango Markets exchange.
After Eisenberg stopped purchasing MNGO with USDC in connection with his fraudulent scheme, the price of MNGO perpetual futures contracts collapsed causing widespread investor harm.
The indictment charged Eisenberg with one count of commodities fraud, one count of commodities manipulation, and one count of wire fraud. Interestingly, there were no securities fraud charges brought by the DOJ. However, Eisenberg is facing parallel civil charges, brought by both the SEC and CFTC. The SEC’s complaint charges Eisenberg with violating the antifraud and market manipulation provisions of § 9(a)(2) and §10(b) of the Exchange Act and Rules 10b-5(a) and (c), and seeks permanent injunctive relief, a conduct-based injunction, disgorgement with prejudgment interest, and civil penalties. The SEC’s case marks the first time that the SEC has alleged that a so-called “governance token” is a security.
B. U.S. v. Wahi (S.D.N.Y. February 7, 2023)
Ishan Wahi, a former product manager with cryptocurrency exchange platform Coinbase, pled guilty to two counts of conspiracy to commit wire fraud premised on the United States’ claim that he misappropriated confidential information in order to trade ahead of public announcements for when new cryptocurrency assets would be listed on the exchange. (See Press Release). Traditionally, defendants in insider trading cases are charged under securities fraud statutes, 15 U.S.C. § 78j and 17 C.F.R. § 240.10b-5. But here, as discussed in our prior posts on Wahi and U.S. v. Chastain, federal prosecutors are using the wire fraud statute, 18 U.S.C. § 1343, likely to avoid having to litigate whether the digital assets involved constitute securities.
Though charged as wire fraud, the case was brought on a tippee-misappropriation theory of insider trading. The USAO SDNY alleges that Wahi violated his duties of trust and confidence to Coinbase when he provided material nonpublic information regarding upcoming listings to his brother and their friend, which allowed both to make profitable trades before the listings were announced. This is the first instance of a defendant admitting guilt to an insider trading theory of wire fraud related to cryptocurrency markets. The USAO SDNY stated “[w]hether it occurs in the equity markets or the crypto markets, stealing confidential business information for your own personal profit or the profit of others is a serious federal crime.” In contrast, Nathaniel Chastain – the first defendant charged with a similar insider trading theory of wire fraud for his conduct involving NFT transactions – has not pled guilty.
Parallel civil proceedings brought by the SEC are pending, though the defendants have moved to dismiss the case arguing, inter alia, that cryptocurrencies do “not fit the legal definition of a security.” Unlike federal prosecutors with the DOJ, the SEC does not have the ability to bring wire fraud charges, and securities fraud charges presuppose that the underlying asset is a security, which under Howey and Reves must be analyzed on a transaction-by-transaction basis.
C. U.S. v. Dubnikov (D. Or. February 7, 2023)
Denis Mihaqlovic Dubnikov pleaded guilty to one count of conspiracy to commit money laundering. (See Press Release). The DOJ was able to connect Dubnikov with the laundering of proceeds from a 2019 ransomware attack against a U.S.-based company. The U.S. company paid 250 Bitcoin as ransom – which was traced, in part, to 35 Bitcoin Dubnikov converted to Tether and later passed on to a second co-conspirator who exchanged them for Chinese Renminbi. Other co-conspirators laundered the remaining Bitcoin proceeds. Dubnikov was arrested in Amsterdam and extradited to the U.S. in August, 2022.
Clearly, regulators are becoming more sophisticated and capable of tracking multiple layers of cryptocurrency transactions structured to launder the proceeds of criminal activity. For a more in-depth discussion of crypto-AML issues, see our related blog-post discussing Coinbase’s settlement with NYDFS.
D. U.S. v. Forsage Founders (D. Or. February 22, 2023)
A federal grand jury in the District of Oregon indicted the founders of the Forsage decentralized finance cryptocurrency investment platform. (See Press Release). The DOJ alleged that the defendants orchestrated a global Ponzi scheme that raised $340 million. The defendants allegedly misled investors by promoting Forsage as a decentralized project based on network marketing and self-executing “smart” contracts on the Ethereum, Binance Smart Chain, and Tron blockchains.
Analysis of the computer code underlying Forsage’s smart contracts allegedly revealed that, consistent with a Ponzi scheme, as soon as an investor invested in Forsage by purchasing a “slot” in a Forsage smart contract, the smart contract automatically diverted the investor’s funds to other Forsage investors, such that earlier investors were paid with funds from later investors.
According to the indictment, the defendants promoted Forsage to the public as a legitimate, low-risk, and lucrative investment opportunity through Forsage’s website and various social-media platforms. However, blockchain analytics confirmed that over 80% of Forsage investors received fewer Ethereum back than they invested in Forsage’s Ethereum program, with over 50% of investors never receiving a single payout. Additionally, as alleged, the defendants used code that fraudulently siphoned investors’ funds out of the Forsage investment network and into cryptocurrency accounts under the founders’ control, which was contrary to representations made to Forsage investors that “100% of the [Forsage] income goes directly and transparently to the members of the project with zero risk.”
The DOJ’s indictment charged each defendant with conspiracy to commit wire fraud – i.e., again not securities fraud. In August 2022, however, the SEC charged Forsage’s founders and seven other individuals with violating the registration provisions of § 5(a) and § 5(c) of the Securities Act, and the anti-fraud provisions of § 17(a)(1) and § (3) of the Securities Act and §10(b) of the Exchange Act and Rules 10b-5(a) and (c). Two of the defendants settled with the SEC without admitting or denying the allegations.
IV. Commodity Futures Trading Commission Crypto Enforcement Actions
A. Vista Network Technologies and Armen Temurian (February 16, 2023)
The CFTC charged Vista Network Technologies, a California-based company, and its CEO, Armen Temurian, with fraudulent solicitation and misappropriation of customers’ digital asset commodities. (See Press Release).
From approximately September 2017 through January 2018, the defendants falsely advertised to customers that Vista would trade their digital assets and earn a 2.5% daily return or “double in just 80 days.” Specifically, the CFTC’s complaint claims that the defendants represented they would trade investors’ bitcoin and ether using “Robot Traders.” However, per the CFTC, these representations were false because the defendants had never traded customer assets and did not have any trading program capable of generating the promised returns. Instead, the CFTC alleges that the defendants engaged in a Ponzi-like scheme, whereby they used new investors’ assets to pay returns to investors who had invested earlier in the scheme.
According to the CFTC’s complaint, the CFTC charged defendants with violations of the Commodity Exchange Act, § 6(c)(1), 7 U.S.C. § 9(1), and Regulation 180.1, 17 C.F.R. § 180.1(a) (2022).
V. FTX-related Enforcement Actions
A. U.S. v. Samuel Bankman-Fried (S.D.N.Y. February 23, 2023)
The DOJ released a superseding indictment in the criminal proceeding against Sam Bankman-Fried. Bankman-Fried, who was originally indicted on eight counts of wire fraud and money laundering, has now been charged with four additional crimes in connection to his operation of FTX. Those include bank fraud, operating an unlicensed money transmitter, a modified campaign-finance law charge, and conspiracy to make unlawful political contributions. (See superseding indictment).
B. SEC v. Singh (S.D.N.Y. February 28, 2023)
As one of three parallel actions brought by the DOJ, the SEC, and the CFTC, the SEC brought and settled charges against Nishad Singh for his role in securities violations committed by FTX Trading Ltd. and related parties. (See Press Release). Singh has agreed to testify in subsequent actions against Bankman-Fried.
Singh was a lead engineer for Alameda, FTX, and related entities; he helped design the code FTX and Bankman-Fried used to funnel FTX client assets to Alameda. Singh had knowledge FTX client funds were directed to Alameda despite public assurances that FTX “was a safe crypto asset trading platform with sophisticated risk management measures to protect customer assets.” Singh was similarly aware that Bankman-Fried’s statements to investors – that Alameda did not receive special privileges from FTX – were false. The features Singh helped design were used to unlawfully direct client funds to Alameda, Bankman-Fried, and other FTX executives. Singh and others at FTX used these features to withdraw client funds even as crypto markets cooled, driving Alameda and FTX towards bankruptcy. Additionally, as Singh became aware FTX would collapse, unable to recoup the client assets it had unlawfully directed elsewhere, he withdrew approximately $6 million from FTX for his personal use.
The SEC’s complaint charges Singh with violating § 17(a)(1) and § (3) of the Securities Act and §10(b) of the Exchange Act and Rules 10b-5(a) and (c) thereunder. Singh consented to a bifurcated settlement, including: an officer and director bar; permanent injunction from future violations of federal securities laws; injunction against participating in the issuance, purchase, offer, or sale of any securities, except for Singh’s personal accounts; disgorgement of ill-gotten gains (amount to be determined by the court); and a civil penalty (amount to be determined by the court). The SEC’s civil case parallels the DOJ’s criminal case. Notably, the SEC’s case does not include allegations that FTX operated as an illegal, unregistered securities exchange or broker-dealer, nor that any of the tokens traded on FTX were, in fact, securities.
C. CFTC v. Singh (S.D.N.Y. February 28, 2023)
At the same time settled charges with the DOJ and SEC were announced, the CFTC also announced that Singh had agreed to the entry of the CFTC’s proposed consent order and did not contest his liability in connection with the CFTC’s claims, which are largely the same as those alleged by the DOJ and SEC. Of note, however, the CFTC’s complaint highlights that it views digital assets as commodities under its regulatory purview and that Singh personally misappropriated FTX customer digital assets. (See Press Release).
The CFTC’s complaint charges Singh with violating the Commodities Fraud, Commodity Exchange Act Sec. 6(c)(1), 7 U.S.C. § 9(1), Commission Regulation 180.1(a), 17 C.F.R. §180.1(a)(2022), as well as aiding and abetting FTX, Alameda, and SBF under 7 U.S.C. § 13c(a).
This is an instance that highlights the lack of bright lines between the jurisdictional purview of the SEC and CFTC.
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This post is part of the Debevoise Fintech Enforcement team’s monthly round-up of recent developments. For any questions or inquiries please contact FintechEnforcement@debevoise.com.
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