Our latest recap of enforcement news centers on The Wall Street Journal’s publication of an article investigating pump and dump operations in the cryptocurrency industry, the SEC’s delay of its decision on CBOE’s application for a bitcoin ETF license, and the denial of the PlexCoin founders’ motion to dismiss the SEC’s civil claims based on personal jurisdiction. Below is a summary of the most interesting enforcement stories from the past week.
Pump and Dump Operations Thrive in the Cryptocurrency Industry. On August 5, 2018, the Wall Street Journal published an article concluding that “[d]ozens of trading groups are manipulating the price of cryptocurrencies on some of the largest online exchanges.” The Journal reports that it reviewed trading data and online communications among traders between January and July 2018 and identified 175 “pump and dump” schemes involving 121 different digital coins and generating at least $825 million in trading activity over the past six months.
In a “pump and dump scheme,” traders talk up the price of an asset (and often times the stock price) and watch as investors buy the asset, which increases the price of the asset, and then the traders quickly sell the asset and earn a profit. Those who are fooled by the scheme lose money as a result of the prices decreasing when the asset is “dumped.”
The biggest group the Journal analyzed was Big Pump Signal, which has more than 74,000 followers on the messaging app Telegram. The Journal concluded that after the launch of the group on Telegram in December 2017, the group has promoted 26 pump operations that resulted in $222 million in trades. The scheme works as follows: Big Pump Signal announces a date, time, and exchange for a pump and then at the set time, it announces or signals the coin being pumped, lets the traders create a buying frenzy, and then quickly sells. The Journal noted that successful traders boast publicly about their earnings in these pump and dump schemes using Telegram.
An example of a recent pump and dump operation by Big Pump Signal, reported on by the Journal, involved an obscure coin called cloakcoin. Big Pump Signal commanded its followers one day at 3 PM to start buying cloakcoin on the exchange Binance. The price of cloakcoin jumped 50% to $5.77 on the exchange before plummeting almost a dollar after two minutes. Approximately 6,700 trades worth $1.7 million were executed, compared with virtually no trading the hour before.
The Journal found 63 groups actively pushing pump and dump schemes and reported that many more groups exist, but operate in private chat rooms accessible only by invitation and overseen by an anonymous moderator. Some of the groups the Journal identified, such as Orion Pump, MEGA Pump, and A+ Signals, do not appear to be hiding their purpose. The Journal noted that it is not known how much the operators of the group profit, but they certainly have an advantage as they select the coin, buy at the bottom and then sell at whatever peak they manufacture. The targets of the schemes are typically coins with just enough trading activity to gain enough interest, pulling in new traders, and inexpensive enough for people to buy a meaningful share.
As the Journal notes, pump and dump schemes are not new. The SEC often brings civil cases regarding pump and dump schemes targeting publicly traded stocks, but has not brought any cases with respect to cryptocurrencies that we are aware of. The Wall Street Journal’s article, however, is sure to have caught the SEC’s attention.
SEC Delays Decision on CBOE’s Bitcoin ETF Application. On August 7, 2018, the SEC filed an update delaying the deadline for the Commission’s decision on CBOE’s application for a Bitcoin ETF license to September 30, 2018. As we recently discussed, in June CBOE filed an application to list and trade shares of SolidX Bitcoin shares.
As we noted a few weeks ago, the SEC’s decision comes on the heels of the SEC’s rejection of a bitcoin-linked ETF application by the Winklevoss twins on July 26, 2018. Currently there are about 10 bitcoin-linked ETFs awaiting regulatory approval. In light of Commission Hester Peirce’s dissent from the SEC’s decision on the Winklevoss twins’ application and a replacement for Commissioner Michael Piwowar winding its way through the political process (as well as a potential upcoming nominee to replace Commissioner Kara Stein), the SEC’s decision on CBOE’s bitcoin ETF and others will be followed closely by those in the industry.
PlexCoin Founders’ Motion to Dismiss Denied. On August 8, 2018, Brooklyn Federal District Court Judge Carol Bagley Amon denied Defendants Dominic Lacroix and Sabrina Paradis-Royer’s motion to dismiss civil claims brought by the SEC related to the PlexCoin ICO. As we wrote back in March, the SEC brought this case in December 2017 alleging that defendants raised approximately $15 million in the PlexCoin ICO from thousands of investors by promising, among other things, an over 1,300 percent profit in less than a month. As we discussed in June, the individual defendants in the case filed a motion to dismiss arguing the Court did not have personal jurisdiction over them because they are Canadian citizens and never intended to sell to U.S. investors.
In a 42-page decision, the Court concluded that the totality of the circumstances “portrays a compelling picture of direct involvement with the United States, and of purposeful creations of effects in the United States.” The Court found that the individual defendants visited Boston to support the PlexCoin project, opened numerous accounts with United States-based payment servicers to facilitate sales that were instrumental to their fraud, and used a variety of websites to disseminate PlexCoin marketing materials, make PlexCoin sales, and court United States-based investors. The Court held that the individual defendants’ physical presence within the United States on their Boston trip “is the quintessential contact supporting personal jurisdiction.” The Court noted that “[m]any of these contacts standing alone might be sufficient to confer personal jurisdiction over this case,” but that the Court did not need to analyze each contact separately.
Judge Amon boiled down the individual defendants’ argument that contacts with the United States were not reasonably foreseeable to reliance on two preventative measures: (1) Lacroix had every potential buyer on the PlexCoin website accept Terms and Conditions which included an exclusion clause providing that “residents of the United States . . . could not directly or indirectly participate” in the ICO; and (2) Lacroix included a checkbox on the website so that potential purchasers could certify that they were not United States citizens or residents. The Court noted that “Counsel for the Individual Defendants conceded to the Court that, if they had not created the checkbox and Exclusion clause, it ‘[m]ost likely’ would have personal jurisdiction over them.” The Court held that the SEC had provided evidence that Lacroix knew the checkbox and Exclusion clause were at least somewhat ineffective, that residents of the United States were purchasers in the ICO, and that Lacroix even removed the preventative measures in an attempt to gain more United States-based purchasers.
This is the first decision to address personal jurisdiction with respect to ICOs. The decision should garner interest and attention in the cryptocurrency industry here in the United States and abroad. The decision not only addresses the reach of courts here in the United States over foreign individuals or companies facing securities charges over their ICOs, but it also addresses safeguards to prevent U.S. investors from participating in an ICO. Because the facts in this case related to prevention measures, such as acceptance of terms and conditions and checkboxes prior to purchase, turned on the fact that the individual defendants ignored the safeguards they set up to avoid selling to U.S. investors, the Court did not comment on the propriety of those prevention methods standing alone. It is clear though from the proceedings in this case that the SEC will be arguing those prevention measures are not adequate regardless of whether you adhere to the safeguards you put in place.