Fraudulent ICOs are a problem for the cryptocurrency industry. They have led to an unfair perception by some that ICOs are frauds and to recent scrutiny by regulators, including the SEC’s recent subpoenas. While there are many startup companies completing ICOs that are perfectly legitimate, there are others that have collected millions of dollars from investors based on false claims, with little more than a website in place. The ICOs that are carefully planned and legitimate are now paying the price as federal and state regulators look to prevent these types of frauds and general uncertainty hangs over the entire industry.
One concern, is that the lawsuits and enforcement actions brought against allegedly fraudulent cryptocurrency startups will result in precedent and regulation that could harm legitimate cryptocurrency companies. It is an old legal truism that bad facts or hard cases lead to bad law. Will that be the case for the cryptocurrency industry? The answer to that question is playing out daily in new indictments and lawsuits brought against cryptocurrency firms.
For example, on Monday the U.S. Attorney for the Southern District of New York announced that a grand jury has returned an indictment of the three co-founders of Centra Tech, Inc., a cryptocurrency startup that once was promoted by boxer Floyd Mayweather and record producer DJ Khaled. Prosecutors charged Sohrab “Sam” Sharma, Robert Farkas, and Raymond Trapani with securities fraud, wire fraud and two conspiracy counts in connection with a scheme to induce investors to purchase Centra tokens.
The indictment alleges that Centra Tech claimed to offer cryptocurrency-related financial products, including a purported debit card, which supposedly allowed users to spend various types of cryptocurrency to make purchases at any establishments that accept Visa or Mastercard. As part of their offering materials for a July 2017 ICO, the indictment alleges that the defendants misled investors that they had formed partnerships with Visa, Inc., MasterCard Inc., and The Bancorp Inc. to issue debit cards, lied about having money transmitter licenses in various states and created a fictitious chief executive officer. The Centra Tech ICO raised over $25 million.
The securities fraud, wire fraud and conspiracy to commit wire fraud charges all carry a maximum potential sentence of 20 years in prison while the conspiracy to commit securities fraud carries a maximum potential sentence of 5 years in prison. The three defendants were arrested last month and the U.S. Attorney’s Office and FBI seized 91,000 Ether worth more than $60 million.
The three defendants have other problems to worry about as well. Back on April 2, 2018, the SEC announced it was charging Sharma and Farkas with violating the anti-fraud and registration provisions of the federal securities laws. On April 20, the SEC amended its complaint to add Trapani as a defendant, alleging that he was the mastermind of the ICO. The SEC is seeking permanent injunctions, return of allegedly ill-gotten gains plus interest and penalties, as well as bars against all three defendants from serving as public company officers or directors and from participating in any offering of digital or other securities. As we noted in a post earlier this week, defendants and Centra Tech are also named in a putative class action lawsuit in the Southern District of Florida alleging that the Centra ICO was an unregistered sale and offering of securities.