The USA v. Maksim Zaslavskiy case is moving forward to trial in the United States District Court for the Eastern District of New York. This morning Judge Dearie decided the allegations in the Indictment, if proved true with evidence, would be enough to find Defendant Zaslavskiy made materially false and fraudulent representations and omissions in connection with two ICO’s he founded, Recoin ICO and DRC or Diamond. The trial jury will be left to decide whether the ICO’s were investment contracts (aka securities).
Zaslavskiy was charged with Conspiracy to commit securities fraud, and securities fraud on both Recoin and Diamond. He tried to dismiss the charges with the ever-so-weak arguments that (1) the ICOs were currencies and not securities, and (2) the securities laws are unconstitutionally vague as applied. Interestingly, he never actually sold anything but a pack of lies because tokens were never issued as promised.
Recoin, a Nevada LLC, proposed to be a real estate investment using “smart” contracts. After the ICO concluded, it was dissolved and merged into Diamond, a Puerto Rican Corporation purporting to pool investments to purchase and safely store insured diamonds in America. Zaslavskiy was the sole owner of both.
The False & Misleading Statements:
Some of the false and misleading statements about REcoin were: (1) “unlike most cryptocurrency, REcoin was uniquely valuable: it was backed by domestic and international real estate investments; (2) REcoin provided investors an “easily accessible financial platform through which people from all over the world could convert their savings into real estate backed currency for the potential of high returns to protect their earnings from inflation”; and (3) REcoin had “some of the highest potential returns..”
See Order: https://www.scribd.com/document/388359304/123114664909-Sept-11-Order.
Additionally, in the REcoin White Paper, it was stated that investors could change their money into “a more stable and secure investment: real estate,” which “grows in value.” Also, “REcoin was led by “an experienced team of brokers, lawyers, and developers and proceeds were invested into global real estate based on the soundest strategies.” See REcoin White Paper. Investments could be made on their website via credit card, virtual currency and online funds transfer.
Likewise, the Diamond White Paper said Diamond intended to “indefinitely prolong its lifespan and development to increase liquidity, visibility and enhance its credibility worldwide.” It also projected 10–15% annual growth.
Surprise surprise, they never bought any real estate or diamonds with the ICO proceeds and they never hired a broker, or a lawyer, or a developer. They never developed tor distributed anything to investors.
An indictment was presented to a grand jury, and the trial was called. It was determined that no matter what label, “Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.” Quoting Reves v. Ernst & Young, 494 U.S. 56, 61 (1990). Zaslavskiy’s “core nature of his alleged criminal endeavors . . . charges a straightforward scam, replete with the common characteristics of many financial frauds” (@ToneVays — they copied your language!)
The Order also states that the questions of whether the coins were securities, currency, or another financial instrument altogether is left for the fact finder (jury) unless the Court is able to answer it as a matter of law after the close of evidence at trial. “Nevertheless, the parties engage in a spirited debate that is undoubtedly premature.”
Defendant’s weak arguments:
Zaslavskiy argued that the tokens were not securities (or investment contracts) and therefore the Government didn’t have criminal or civil enforcement power over him. It was decided that his reading of the law was overly narrow.
While Congress has yet to describe an investment contract, the Howey Test is the basis, and it is a factual inquiry. “The question is whether the “elements of a profit-seeking business venture” are sufficiently alleged in the indictment, such that, if proven at trial, a reasonable jury could conclude that “investors provide[d] the capital and share[d] in the earnings and profits; and the promoters manage[d], control[led] and operate[d] the enterprise.” See SEC v. Howey, 328 U.S. 293, 300 (1946). The indictment alleges enough facts that if proven at trial, could lead a reasonable jury to find that REcoin and Diamond were “investment contracts” within the meaning of a Security.
How Zaslavski allegedly violated the Howey Test:
Howey Prong 1 — Investment of Money — Zaslavski said REcoin and Diamond did not involve an investment of money, rather they sold memberships. The Order cited four Securities Law cases that stated “cash is not the only form of contribution or investment that will create an investment contract . . . the ‘investment’ may take the form of ‘goods and services’ . . . or some other ‘exchange of value.’” (quoting lnt’l Bhd. Of Teamsters, Chauffeurs, Warehousemen & Helpers of Am. v. Daniel 439 U.S. 551,559 (1979); Hocking v. Dubois, 88 F.2d 1449, 1471 (9th Cir. 1989)). See also Uselton v. Commercial Lovelace Motor Freight, Inc., 940 F.2d 564,574 (10th Cir. 1991); Alcox v. Uselton, 502 U.S. 893 (1991).
Howey Prong 2 — Common Enterprise — To allege a common enterprise, the Indictment must establish that “commonality” existed between the investors in REcoin, and Diamond. In the Second Circuit, “horizontal commonality” is enough to establish a common enterprise. See Revak v. SEC Realty Corp.. 18 F.3d 81, 87–88 (2d Cir. 1994). Horizontal commonality is basically when the investors have pooled their assets and expect a pro rata distribution of profits — kind of like stock’s dividends). See In re J.P. Jeanneret, 769 F. Supp. 2d at 359; Marini v. Adamo, 812 F. Supp. 2d 255 (E.D.N.Y. 2011). Because REcoin and/or Diamond would require the pooled funds of its investors to buy the real estate or diamonds, a reasonable jury could find this element satisfied.
Howey Prong 3 — Expectation of Profits — Here, if the alleged facts were proven, a reasonable jury could conclude that the investors expected a profit that would come solely from the managerial efforts of Zaslavskiy. See SEC v. Edwards, 540 U.S. 389, 393 (2004) (“a touchstone of an investment contract is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”) Profits have been defined as “simple financial returns … and may include dividends, periodic payments, or the increased value of the investment.” Id.
Jury MIGHT find Securities were sold:
Today, the EDNY Judge Raymond Dearie, simply concluded that IF the allegations in the Indictment are proven, a reasonable jury MIGHT conclude that Zaslavskiy promoted investment contracts (aka securities).
Due Process Analysis:
The Defense also stated that the Due Process clause was violated because Securities laws are too vague to give ordinary people fair notice, and invites arbitrary enforcement.
Judge Dearie stated that the Indictment against Zaslavskiy satisfies the two prongs it has to, 1) it is understandable by a person of ordinary intelligence, and 2) the Howey Test definition makes it reasonably clear that the charged conduct was criminal. (For over 70 years this test has provided guidance to courts and litigants as to the definition of “investment contract” under the securities laws. SEC v. SG Ltd., 265 F.3d 42, 48 (1st Cir. 2001); see also SEC v. Brigadoon Scotch Distrib. Co., 480 F.2d 1047, 1052 (2d Cir. 1973), (argument that “investment contract” in the Securities Act was void for vagueness was “untenable,” “in light of the many Supreme Court decisions defining and applying the term”).
It was also noted that Zaslavskiy was warned by the SEC specifically that crypto could be considered securities in the DAO report, and in multiple other public statements made by the SEC. See http://www.sec.gov/news/public-statement/statement-clayton-2017-12-11 (“simply calling something a ‘currency’ or a currency-based product does not mean that it is not a security”).
This case will proceed to trial, and a jury will decide whether or not the REcoin and Diamond were sold as securities. I expect it to be an easy decision in favor of the government.