On September 11, 2018, Judge Raymond Dearie of the Eastern District of New York rejected a motion to dismiss in U.S. v. Zaslavskiy, the first criminal securities fraud prosecution relating to an initial coin offering. The motion to dismiss challenged the prosecution's characterization of two virtual currencies promoted by Maxim Zaslavskiy as “securities" under the federal securities law.
In rejecting the motion, Judge Dearie determined only that a reasonable jury could conclude that the alleged coins satisfy the Howey test and that, as such, the question of whether these ICOs constituted offerings of securities is a question of fact to be determined by the jury. In scholarly and practitioner discussions of the potential applicability of the securities laws to ICOs, the most difficult question is typically whether the profit "through the efforts of others" component of Howey is satisfied insofar as many virtual currencies do not involve a clear link between managerial efforts and expected profits. In Zaslavskiy, however, Judge Dearie held that the alleged facts make “clear that the investors could have reasonably expected their profits to be derived primarily from the managerial efforts of Zaslavskiy and his team." Zaslavskiy is alleged to have marketed one coin as “real estate-backed currency" whose value was derived from real estate investment decisions managed by “an experienced team of brokers, lawyers, and developers." The other coin was similarly marketed as a currency whose value was derived from expert investments in diamonds. In both cases, the court noted that there was no indication that investors were to be given any opportunity to manage the real estate and diamond investments “backing" the virtual currencies and that the expected profit from these currencies was to be derived from the investment strategies of Zaslavskiy's “expert" team.
As the first instance of a federal court opining on these questions in a criminal context Judge Dearie's findings are notable; however, as with the SEC's 2017 DAO ICO investigative report, the court's analysis has limited generalizable implications. The alleged facts of the coins forming the subject of the criminal complaint allowed for a straightforward application of Howey and accordingly the ruling provides relatively little guidance as to how federal courts will apply the securities laws to the often more ambiguous character of many ICOs. Practitioners will undoubtedly watch the resulting criminal trial with interest.
This post was prepared by Alan Bannister, Nicolas Dumont, and Michael Mencher.