On May 8, lawyers in the case of U.S. v. Zaslavskiy presented arguments before Judge Raymond Dearie in the Eastern District of New York on Maksim Zaslavskiy’s motion to dismiss a criminal securities fraud indictment filed last November. Zaslavskiy, in a brief filed by the criminal defense attorneys who were appointed to represent him, argued that the indictment should be dismissed because the securities laws do not apply to cryptocurrencies and because the securities laws are unconstitutionally vague as applied to cryptocurrencies. The Department of Justice filed a brief opposing the motion to dismiss, arguing that cryptocurrencies are investment contracts under Howey and that Howey and its progeny put Zaslavskiy on notice that his coins were securities.
The oral argument focused on whether cryptocurrencies are investment contract securities under Howey. In addition to Zaslavskiy’s federal public defenders and the prosecutors, there was argument from the SEC (which has filed a parallel civil enforcement action against Zaslavskiy and which filed an amicus brief supporting the government’s request to deny the motion to dismiss) and from Zaslavskiy’s counsel in the civil case.
Although the judge and government appeared to expect arguments to focus mainly on the elements of an investment contract set forth in Howey, one of the defendant's lawyers focused on the vagueness challenge to the securities laws. He noted the number of different regulators bringing enforcement actions before they have released any guidance to issuers. He then assured the court that the SEC can still go after Ponzi schemers for simple fraud even if cryptocurrencies are not securities, contrasting the present case, which is not a Ponzi scheme and does not involve "a guy with a handle bar moustache sitting behind a railroad tying somebody to the tracks.” The court dryly noted that counsel was giving people with handle bar moustaches a bad name.
Some additional highlights from the oral argument include:
Are cryptocurrencies currency?
Defense counsel attempted to avoid Howey at the outset, trying to convince the court that the cryptocurrency that was offered to the public was a currency not subject to the securities laws. He pointed out that real goods and services from places like Subway and overstock.com can be purchased with established cryptocurrencies like bitcoin and ether, and suggested the cryptocurrency at issue is just a less mature version of those currencies.
The judge responded that that argument is an evidentiary question that is “perhaps viable at trial.”
The government rejoined that the coins were so illiquid that they could not function as currency. The government also pointed to the advertisements for the ICO that do not focus on the functionality of the coins, but on the possibility of re-selling them for profit.
Difficulty of applying Howey?
The judge noted several times the difficulty of applying Howey to a digital currency. Responding to the government’s argument that the advertisements for the ICO talked about “high returns,” the judge wondered: “I guess it is possible that it’s both [an investment contract and a currency]? Don’t panic, folks.” He went on to note that “we are in a new world” and “back in the Howey days we were not talking digital currencies.” At the end of the hearing, the judge said “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 me.”
Question of Fact or Law?
Judge Dearie suggested that the question presented may be a question of fact for a jury, noting he has had a jury decide what constituted an investment contract before. If the Judge reserved judgment for the trial jury, a decision would not come before January 2019, when trial is scheduled. There was discussion of how the jury would be instructed and potentially contradictory decisions a jury could render, but the judge ultimately found that the question of jury instructions was not ripe at this stage.
Although many people are touting this case as likely to bring clarity to ICO regulation, that is not necessarily the case. Judge Dearie’s ruling may be limited to facts not widely applicable to other ICOs or he may withhold ruling as a matter of law and send the question to a jury. Moreover, with so much ICO litigation filed recently, it is possible another court could rule before Judge Dearie. And given the ICO litigation is dispersed in jurisdictions both state and federal across the country, it is possible that we may see inconsistent decisions that result in less clarity for the market.
John Reed Stark Consulting has posted the transcript along with key background and commentary on the hearing.
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