Federal Court Sustains Criminal Securities Fraud Case Over Initial Coin Offering

U.S. District Judge Raymond J. Dearie of the Eastern District of New York ruled Tuesday that a criminal case alleging that Maksim Zaslavskiy committed securities fraud in connection with the sale of cryptocurrency tokens may proceed to trial. The government claims that Zaslavskiy defrauded more than a thousand investors by lying about the prospects of his initial coin offerings, REcoin and Diamond, that ran approximately from January to October 2017.

The case revolves around a contentious legal issue in the world of cryptocurrency, which before now received little guidance from the courts. Namely, whether investors in risky initial coin offerings are protected by the federal securities laws. The Department of Justice and the Securities and Exchange Commission indeed argued that, rather than merely being a new form of currency, the tokens that Zaslavskiy allegedly sold to thousands of investors were “investment contracts”, and therefore securities subject to federal law.

Under the government’s “investment contract” theory, the token in question would need to satisfy a legal test known as the “Howey Test” to be properly classified as a security subject to federal law. Initially set forth by the U.S. Supreme Court in the 1946 case of S.E.C. v. W.J. Howey Co. et al, the Howey Test requires the government to show that Zaslavskiy’s initial coin offerings (1) involved investments of money (2) in a common enterprise and (3) with the expectation of profits derived from the efforts of the promoter.

In a 22-page opinion, Judge Dearie, though noting that the government must still prove each element of the test at trial, ruled that the facts as-alleged by the government support their position that Zaslavskiy’s initial coin offerings satisfy the elements of the Howey Test. Zaslavskiy would face the potential of severe criminal penalties, including the possibility of a prison sentence, if the jury agrees with the government that he willfully defrauded investors by issuing materially false or misleading statements in connection with the sale of securities.

In addition to the present criminal case against Zaslavskiy, there are numerous securities class action lawsuits pending in federal court over initial coin offerings, including cases against Paragon Coin, ATBCoin, and Bitconnect. As we wait to see how this new development in federal securities law plays out, the public is encouraged to exercise caution and sound judgment when deciding whether to invest in cryptocurrencies or initial coin offerings.