Bloomberg reported on September 11 that a US Judge has ruled that ICOs are covered under US securities laws, handing US regulators a legal victory in their effort to regulate the burgeoning ICO market.
The ruling is in relation to a criminal case filed against a man charged with promoting digital currencies backed by investments in real estate and diamonds that prosecutors said do not exist. US District Judge Raymond Dearie of Brooklyn, New York, ruled on Tuesday that the prosecution can move forward with a case that claims an ICO is a security for purposes of US federal criminal law.
With more than $18 Billion raised in 2018 alone by ICOs, many have started calling for regulations for the ICO market. The chairman of the US SEC, Jay Clayton, has publicly stated that the fundraising method should become regulated, and the chairman adds that he thinks the ICO market has become filled with fraud due to the popularity of digital currencies and blockchains.
Peter Henning, a professor at Wayne State University’s law school in Detroit, commented on the ruling, saying that:
“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. The defense here was arguing that it’s not a security, but the judge has rejected that claim, saying that this case can fit under the securities laws, and that’s an important first step.”
Courts To Decide If ICOS Can Be Regulated
The case, which prosecutors claim is the first prosecution of its kind, involves Brooklyn businessman Maksin Zaslavskiy. He was charged with conspiracy and two counts of securities fraud for his alleged role in defrauding investors in two ICOs. Zaslavskiy argued that the ICOs at the core of the issue weren’t securities but were instead currencies. He also argued that current securities law are too vague to be applied to initial coin offerings.
Judge Dearie said in his ruling on Tuesday that the decision would ultimately have to come from a jury on whether the ICO in question is a security, but the allegations would support such a finding. The judge’s decision also focused on the particulars of the alleged ICOs, not on other ICO transaction. If the ruling is upheld on appeal, it could have broader and more far-reaching implications.
Judge Dearie noted in his hearing that:
“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. Simply labeling an investment opportunity as a ‘virtual currency’ or ‘cryptocurrency’ does not transform an investment contract — a security — into a currency.”
Federal regulatory agencies have urged investors to be cautious about investing in ICOs and have recently stepped up efforts to police the ICO market.
Chairman Clayton has stated his belief that the majority of ICO offerings should be registered and that the coins trade on secondary markets like securities the SEC regulates. However, many ICOs have been slow to subject themselves to regulatory oversight, with just a very few firms registering with the SEC. Clayton previously stated in January that the SEC would sanction more firms “if people don’t change their ways.”
Investment Contracts, Not Currencies
Prosecutors working the case argue that investments offered by Zaslavskiy in the two ICOs, ReCoin Group Foundation and Diamond Reserve Club, were “investment contracts” which are considered securities under federal law.
Prosecutors further claim that investor in the ICOs never received any digital assets, nor did the businessman purchase any real estate, hire a broker or sell more than 2.8 million tokens as he claims in marketing materials.
Gregory Xethalis, an attorney at Chapman & Cutler LLP, who specializes in cryptocurrency-related issues, noted that the court rejected the defendant’s argument that current federal securities laws were too vague to put him on notice that they applied to his alleged conduct.
Xethalis says that:
“It demonstrates that you can’t rely on an argument that the law is insufficiently clear and put your head in the sand. It’s saying that operating in a grey area will not bar the court from hearing cases that allege securities laws violations in ICOs.”
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