ICOs are gaining more and more popularity as they represent a new form of fundraising. The SEC has provided guidance, warning that sales of digital tokens to U.S. persons in ICOs are exceedingly likely to be sales of investment contracts and, consequently, sales of securities.
The U.S. District Court for the Eastern District of New Your issued a Memorandum and Order, the Zaslavskiy Order. Maksim Zaslavskiy is responsible for providing important guidance to token sellers. It is crucial to understand that the Court hasn’t determined Zaslavskiy’s token sales as sales of securities.
The Zaslavskiy Order denied Zaslavskiy’s pre-trial motion to dismiss a criminal indictment and determined that “the case will proceed to trial.”
The SEC along with the United States Department of Justice, filed a lawsuit against Zaskavskiy, stating alleged securities fraud in connection with two ICOs. The first ICO was connected to diamonds, and the second is linked to real estate.
Zaslavkiy filed a motion to dismiss both allegations but was denied. The Court stated:
“Because the Indictment is sufficient under the Constitution and the Federal Rules of Criminal Procedure, and because the law under which Zaslavskiy was charged is not unconstitutionally vague as applied, Zaslavskiy’s motion is denied.”
Whether an Investment Contract Exists Is a Question of Fact
Like some reported, and others speculated, that the Court determined that Zaslavskiy’s token sales were sales of securities, which is not the case. To the contrary, Judge Dearie reminded the Court that it is yet to be determined based on the evidence and the Howey test. The Zaslavskiy Order states:
“The subsidiary question of whether the conspirators, in fact, offered a security, currency, or another financial instrument altogether, is best left to the finder of fact—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. The Court has been treated to a volley of cases decided in the civil arena, which may well be instructive at the appropriate time but do not inform us as to whether the Indictment itself is fatally flawed. The parties also encourage the Court to evaluate documents and evidence outside of the four comers of the Indictment, which we decline to do[….] Despite the parties’ attempt to cast, this issue as one related to the Indictment’s facial sufficiency, they have instead asked us to resolve what can only fairly be a question of proof at trial, based on all of the evidence presented to a jury. Zaslavskiy’s primary contention—that the investment scheme at issue did not constitute a security, as that term is defined under Howey, is undoubtedly a factual one. [….] In any event, we briefly examine the parties’ exchange and confirm our conclusion that the Indictment calls for a trial on the merits.”
The Indictment Was Facially Valid
The Court determined that the Indictment was facially valid, meaning that it “satisfies the demands of due process and gives the defendant clear notice of the charges against him.”
What was also determined by the Court is if the allegations in the Indictment were proven, the jury could come to a conclusion that the token sales passed the Howey test, and were indeed sales of investment contracts.
Judge Dearie added:
“However, the ultimate fact-finder will be required to conduct an independent Howey analysis based on the evidence presented at trial.”
The Law under which Zaslavskiy Was Charged Is Not Void for Vagueness As Applied
The Court also concluded that the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 thereunder are not unconstitutionally vague (“void for vagueness”) as applied.
The Court stated:
“Whether or not the investments promoted in the REcoin and Diamond are cryptocurrencies is beside the point at this stage. The question is whether the law under which Zaslavskiy is charged is unconstitutionally vague as applied to his conduct, as it is described in the Indictment. It is not. Zaslavskiy had failed to demonstrate that a person of ordinary intelligence would not have sufficient notice that the charged conduct was prescribed.”
The SEC and other regulators made a lot of public statements regarding digital tokens so far. It is imperative that those ’’who dwell in the crypto world,’’ be aware of warnings and guidance provided by the SEC.
In these early cryptocurrency cases, it is imperative that parties are represented by lawyers who fully understand both the digital token space and the relevant regulatory guidance.
The verdict of the Zaslavskiy case still remains to be revealed, but as the Court stated:
“The case will proceed to trial.”