A federal court in Brooklyn, New York, entered an order of permanent injunction, imposed a civil penalty of approximately US $871,000, and ordered restitution of approximately US $290,000 against Cabbagetech Corp. and Patrick McDonnell, its owner and controller, in connection with a lawsuit brought by the Commodity Futures Trading Commission that charged the defendants with unlawfully soliciting customers to send money and virtual currencies for virtual currency trading advice and for the discretionary trading of virtual currencies. However, alleged the CFTC, the defendants did not provide the promised services and misappropriated their customers’ funds.
In ruling against the defendants, the federal court again held that virtual currencies are commodities and that the CFTC had jurisdiction to bring its enforcement action relying on the fraud-based manipulation prohibition in the Dodd-Frank Wall Street Reform and Consumer Protection Act and a parallel CFTC rule. (Click here to access Commodity Exchange Act Section 6(c)(1), 7 U.S.C. § 9(1) and here for CFTC rule 180.1)
Previously, defendants had made a motion to dismiss the CFTC’s case on the grounds that the Commission had no authority to bring its action. In March, however, the court upheld the authority of the CFTC to exercise its enforcement power in connection with alleged fraud in the sale of virtual currencies in interstate commerce even where the purported wrongdoing related to spot transactions in such commodities and not derivatives based on such commodities. (Click here for further background in the article “A Court, Treasury and the SEC Confirm Substantial Overlap in US Jurisdiction of Cryptocurrencies” in the March 8, 2018 edition of Between Bridges.)
Mr. McDonnell subsequently requested a reconsideration of the court’s ruling based on a May 1, 2018, federal court decision in California involving Monex Deposit Company and other defendants. There, the court held that the CFTC could not use the fraud-based manipulation prohibition adopted as part of Dodd-Frank to prosecute acts of purported fraud alone; a detrimental market impact must also be alleged. However, the Brooklyn federal court rejected Mr. McDonnell’s request for reconsideration noting that it took a different view than the California court regarding the CFTC’s authority. (Click here for background in the article “Federal Court in Brooklyn Rejects Application of California Decision as Basis to Dismiss Pending CFTC Cryptocurrency Fraud Suit” in the July 22, 2018 edition of Bridging the Week.)
Mr. McDonnell generally represented himself in the CFTC litigation without the assistance of counsel.
Legal Weeds: Decisions in response to motions to dismiss are still outstanding in two important enforcement actions involving cryptocurrencies where defendants challenge the jurisdiction of the CFTC and the Securities and Exchange Commission over certain crypto tokens.
A federal court in Massachusetts is expected to rule soon on a motion to dismiss made by Randall Crater and the relief defendants in the CFTC’s My Big Coin Pay, Inc. enforcement action filed earlier this year. In that action, the CFTC claimed that My Big Coin Pay, Inc. and two persons closely involved with the company – Mr. Crater and Mark Gillespie – allegedly engaged in a virtual currency scheme that misappropriated approximately US $6 million from 28 or more persons from at least January 2014 through January 2018.
Mr. Crater and the relief defendants argued in papers to support a motion to dismiss that the CFTC has no jurisdiction to bring its enforcement action alleging fraud in connection with the sale of the virtual currency known as “My Big Coin,” because the virtual currency was not a commodity under applicable law. This is because, said the defendants, the virtual currency was neither a good nor an article, service, right or interest in which contracts for future delivery are dealt in. If My Big Coin is not a commodity, the CFTC had no authority to prosecute a fraud case against them under applicable law, claimed the defendants.
The defendants also argued that the CFTC had no standing to bring a general anti-fraud case against them relying on a fraud-based manipulation prohibition adopted as part of Dodd-Frank. (Click here for background in the article “CFTC Sues Unregistered Company and Promoters of Fake Virtual Coin for Alleged Fraud and Operating Purported Ponzi Scheme” in the January 28, 2018 edition of Bridging the Week.)
Separately, Maksim Zaslavskiy moved to dismiss a criminal complaint that had been filed against him in November 2017, charging that he engaged in illegal unregistered securities offerings and securities fraud in connection with the offering of digital tokens through initial coin offerings organized by two of his companies, REcoin Group Foundation, LLC and DRC World, Inc. Among other things, Mr. Zaslavskiy claimed in his motion that the digital tokens he tried to create were not securities but cryptocurrencies and that all currencies – fiat and otherwise – are not securities under applicable law. (Click here for background in the article “Federal Court, Treasury and SEC Provide Further Guidance on Cryptocurrencies; Subject of Criminal Complaint for ICO Asks Court to Dismiss Prosecution Claiming Cryptocurrencies Are Not Securities” in the March 11, 2018 edition of Bridging the Week.)