The great land of the free will have twelve ordinary individuals randomly selected across the nation to decide a monumental 21st century question: are tokens a security?
That’s the indication given at a pre-trial hearing of the United States v. Maksim Zaslavskiy by Judge Raymond Dearie (pictured) where the battle-lines were set for this historic case.
As background, the defendant is accused of securities fraud by failing to register with the SEC and by misleading investors in an Initial Coin Offering (ICO).
The defendant raised around a million dollars in a token sale with the aim of creating a platform to tokenize property and/or diamonds. SEC alleges the defendant had taken no steps to buy property or diamonds to back the tokens. The judge describes the factual background fairly succinctly:
“It’s fair to say I think we all agree that the picture the government paints in its papers as opposed to the picture the defendant paints in its papers are very different, very different indeed.
They are ships not only crossing in the night, they are on different seas entirely. There’s going to be some sort of factual resolution down the road, not by me, presumably by a jury.
Indeed, it occurred to me, with the help of my clerks, that I had at one time in the past charged a jury on the question of what is an investment contract. . It didn’t become a big issue in the case itself.
The jury was asked to consider whether or not we were dealing with investment contracts that didn’t involve digital currency and supposed digital currency. It’s a case not unlike what we have here…
That gets me to one final preliminary, from whose perspective do I look at this? We have the government’s perspective, this whole thing is a sham from start to finish. There were no coins, there were no diamonds, there was no real estate, etcetera, etcetera, etcetera.
The defense presents a very different picture that notwithstanding admissions of Mr. Zaslavskiy there was a full intention to develop this into what he regarded as a viable digital currency.
Then we have the perspective of the victims themselves. Some might say, for example, I was investing my money in a common pool in the hopes of getting a return, as the white paper promised, through the efforts of others.
Some might say, you know, I was intently interested on establishing a viable, working digital currency and this promised me that with the added security of hard assets, real estate or diamonds, to back it up.”
The question here isn’t whether there was fraud, although that itself might be contested, but whether it is specifically securities fraud, or as the defendant’s lawyer says:
“Let’s take a commodity that there’s no question is not a security. We’re talking about gold bars. There was a scheme where a defendant solicited investments in gold bars and he was selling gold bars and what they were actually selling was pyrite, fool’s gold.
That allegation would make out a fraud. It wouldn’t be the type of fraud that was covered by the securities act.”
The defense is taking the position the token is a currency, or otherwise a commodity, but the judge suggested some aspects sure look like an investment contract, i.e. a security. Then the judge says something the defence hangs on to, judge says:
“We are in a new world here, right? Back in Howey days we were not talking digital currencies. You will concede, Ms. Nestor [gov’s lawyer], will you not, that there are characteristics — again, I fully understand your position that this was a nothing burger, it was a fraud from top to bottom. I understand that. But assume for a moment the hypothetical along the lines that it’s presented in the defendant’s papers. There are characteristics of both currency and investment.”
That might ruin the government’s case, with their lawyer at one point suggesting they might drop the matter and go for simple fraud, rather than securities fraud. If they do so however, they would be conceding and admitting that tokens are not securities. So the lawyer emphasized that they might, rather than will.
That might ruin the government’s position because of constitutional vagueness as the Securities Act exempts currencies from being a security. The two lawyers thus fight it out with the defence hanging onto: what if they are both? Mr Kamdang, defence lawyer, says, and we quote at some length:
“Across the hallway in Judge Weinstein’s courtroom he’s ruled that virtual currencies are commodities. In this courtroom we’re 20 feet across and the government is now saying that these are securities.
THE COURT: Did Judge Weinstein rule that they were not securities?
MR. KAMDANG: He said that it’s possible they could be regulated by both. It was a helpful opinion. I think our concern though is that this type of outcome is a determinative analysis.
The SEC wants to regulate something so they declare something as a security. For the court to rubber stamp that without the authority and rulemaking, there’s flow definition that makes clear this is not currency.
Your Honor asked an interesting question. What if it’s a currency and it’s an investment contract? We don’t have guidance on that and the fact that what we’re seeing on the same floor in the same courthouse in Brooklyn, New York the government alleges that these are different things depending on the agency that wants to bring it, I think that raises vagueness concerns and I think that the court should think about that and think about the role that the court should play…
MR. KAMDANG: The court would also have to instruct the jury on what currency is and if a jury were to have to answer the question — what if the jury answered the question we think it’s a currency and we think it’s an investment contract and the jury came to an affirmative answer on both. There’s no guidance.
THE COURT: You have problem.
MS. NESTOR: I disagree the court would have to instruct the jury it’s also a currency. The court would have to make a decision that it’s either an investment contractor or a currency. They could find it’s not an investment contract. They should not be given a choice as to what it should be….
MR. KAMDANG: I think right now we can forecast that problem without knowing — I don’t think the court needs to go all the way to get to a jury verdict to know it’s possible that a jury could find that something is a currency and an investment contract and we have no guidance on what to do there.
MS. NESTOR: Your Honor, I disagree. That can only happen if you give the jury 17 different options. You can find one of these options. That’s not what the jury instructions are all about.
THE COURT: If we got to that point, we would have to have that sort of discussion. I have to accommodate the defense, if it is indeed a legal defense, by way of an instruction to the jury. I’m not sure what the answer to that is. I would have to think about that.”
A trial date has been set for January 7th 2019, with a jury now to decide whether tokens are a security and, in addition, whether they are a currency.
If the jury finds as a matter of fact that these sort of ICOs are not a security, or are a security, appealing would be difficult if at all possible for it would not be a matter of law, but a matter of fact.
If a jury finds they are a security but are also a currency, then the Securities Act would not apply to tokens for it contradicts itself, thus making it unconstitutional as far as tokens are concerned. That would mean SEC would not have jurisdiction either.
Whether in that case or if the jury finds they are not a security, then CFTC would have jurisdiction for underlying fraud, but wouldn’t have regulatory oversight.
No one would in that instance, except for money transmitter laws. There would still be plenty of laws that cover fraud or scams, but ICOs would not need to be registered with the SEC, with only enforcement action in criminal cases left for the government, or contractual action in civil cases for affected parties.
This will probably be the biggest case of this decade for the guarantor of our liberty, the jury, will be showcased to the entire world, with their monumental judgment to decide how innovation in the land of the free is to evolve.
“It would be wonderful if the regulators, you know, got into the 20th century, much less the 21st and we would be able to avoid some issues. I have to deal with the cards that have been dealt.” – Judge Raymond Dearie.