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QE on the Block - Digital Assets and Blockchain Newsletter - Fall 2023

November 09, 2023

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Criminal Litigation

  • SBF Found Guilty of Seven Counts of Fraud. On November 2, the former CEO of fallen crypto exchange FTX was found guilty on all seven counts of fraud and conspiracy leveled against him.  Over the course of the month-long trial, the prosecution accused Bankman-Fried of building an elaborate “pyramid of deceit” on a “foundation of lies and false promises,” highlighting the testimony of witnesses including Caroline Ellison, Bankman-Fried’s ex-girlfriend and former CEO of Alameda Research, Gary Wang, co-founder and CTO of FTX, and Nishad Singh, the exchange’s director of engineering, that Bankman-Fried orchestrated the diversion of billions of customer funds. In contrast, defense counsel portrayed Bankman-Fried as a “nerdy high school math guy” who unwittingly became the center of the government’s movie-villain narrative.  The jury deliberated for less than five hours before coming to a verdict.  Bankman-Fried will be sentenced on March 28, 2024 and faces up to 110 years in prison. 
  • Oyster Pearl Crypto Founder Gets 4 Years for Tax Fraud. On October 31, Amir Bruno Elmaani was sentenced to four years in prison—the maximum statutory sentence—for tax offenses in connection with the Oyster Pearl token he founded under the pseudonym “Bruno Block.”  Elmaani had pled guilty earlier this year to secretly minting and selling Pearl tokens for his own profit, thus causing the price of the tokens to plummet, and failing to pay $5.5 million in income taxes on the gains.  According to the DOJ, Elmaani funneled crypto proceeds through friends and family to his own accounts, from which he took out $10 million to purchase real estate, home renovations, and yachts which he used to store his gold bar collections. 
  • Airbit Club Co-Founders Get Prison Time. On September 26, New York District Judge George B. Daniels sentenced Pablo Renato Rodriguez to 12 years in prison for running a multimillion dollar cryptocurrency pyramid scheme.  Judge Daniels also sentenced co-founder Gutemberg Dos Santos, who cooperated with federal prosecutors, to 40 months in prison on October 4.  Rodriguez, Dos Santos and other promoters had allegedly lured investors to buy “memberships” in Airbit Club with the false promise that they would earn returns on cryptocurrency trading, and then spent those funds on luxury travel, jewelry, and real estate. 
  • Former Celsius Exec Pleads Guilty to Fraud Charges. On September 14, Roni Cohen-Pavon, former chief revenue officer at now-bankrupt exchange Celsius Network, pled guilty to four criminal charges, including securities fraud and manipulating the price of the company’s token CEL.  In July, Prosecutors charged Cohen-Pavon and Celsius founder Alex Mashinsky with misleading investors and siphoning customer funds from the platform into their own pockets.  Cohen-Pavon’s sentencing is set for December 2024.  According to the plea agreement, he may be eligible for leniency if he agrees to cooperate against Mashinsky, whose trial will start September 2024.
  • OneCoin Co-Founder Sentenced to 20 Years. On September 12, New York District Judge Edgardo Ramos sentenced Karl Sebastian Greenwood to 20 years in prison and ordered him to forfeit $300 million for his role in a multibillion dollar pyramid scheme.  Greenwood founded OneCoin in 2014 with “CryptoQueen” Ruja Ignatova, luring 3.5 million people into investing over $4 billion in a cryptocurrency with no intrinsic worth.  The victims, prosecutors noted, are unlikely to recover any of their money.  Ignatova remains at large.
  • Collapsed Crypto Exchange Founder Sentenced to 11,196 Years. On September 8, a panel of judges in Turkey sentenced Faruk Fatih Ozer, the founder of defunct crypto exchange Thodex to 11,196 years in jail.  Thodex was one of Turkey’s largest crypto exchanges until April 2021, when $2 billion in investor assets suddenly disappeared and Ozer went into hiding.  According to the BBC, such long prison sentences are relatively common in Turkey.  Prosecutors had sought 40,000 years for Ozer on charges of fraud, money laundering, and operating a criminal organization. 
  • Salame Pleads Guilty to Fraudulent Contribution Charges. Former FTX Digital Markets chief executive Ryan Salame pled guilty on September 7 to funneling tens of millions of dollars from Alameda Research into political donations in his own name in a bid to boost the company.  Salame agreed to forfeit $1.5 billion and pay $5.6 million in restitution to FTX debtors.  Unlike plea deals for other top FTX executives, the deal did not include an agreement to cooperate with authorities against ex-CEO Sam Bankman-Fried.

Governmental Action

  • SEC Drops Claims Against Ripple Executives. On October 19, 2023, in a decision Ripple lauded as a “landmark SEC surrender,” the SEC dropped its civil claims against Ripple CEO Brad Garlinghouse and co-founder Chris Larsen, which had been set for trial following a summary judgment decision regarding other claims in the SEC’s case against Ripple.  The SEC had claimed that the two executives aided and abetted Ripple’s sale of unregistered securities.  Earlier this year, U.S. District Judge Analisa Torres dealt a blow to the SEC’s case by ruling that various alleged XRP transactions were not unregistered sales of securities.
  • SEC Brings Suit Against Prager Metis For Auditor Rule Violations. On September 29, 2023, the SEC filed suit in the Southern District of Florida seeking a permanent injunction and disgorgement of profits against Prager Metis, one of the auditors which provided services to FTX prior to its bankruptcy.  Specifically, the SEC alleges that Prager entered into agreements whereby its clients agreed to indemnify Prager for any liability arising out of the auditor’s own negligence.  The SEC’s auditor rules specify that this kind of indemnification provision is impermissible for an independent auditor.  The SEC alleges that Prager entered into at least 51 engagement letters containing such indemnification agreements.
  • LBRY Drops Appeal of Ruling That Its Token Is An Unregistered Security. On September 7, Blockchain-based digital content network LBRY Inc. filed a notice of appeal challenging a New Hampshire federal judge’s ruling that certain transactions in the company’s native token, LBC, were unregistered securities transactions.  But, on October 20, LBRY dropped the appeal, stating in a blog post: “LBRY Inc. has debts to the SEC, its legal team, and a private debtor that it cannot pay. Its assets, including Odysee, are being placed into receivership. As of this post, all LBRY executives, employees, and board members have resigned. All will be doing what is required to satisfy any outstanding legal requirements, but no more.”
  • NY AG Alleges That Gemini and Genesis Defrauded Investors of Over $1B. New York Attorney General Letitia James filed suit in New York state court on October 19, alleging that crypto exchange Gemini, bankrupt crypto lender Genesis, and its parent company Digital Currency Group lied to investors about the level of risk involved in the Gemini Earn program.  The suit also alleges that DCG and Genesis concealed from Gemini Genesis’ financial condition and lied about $1 billion in losses as the company headed towards collapse in 2022. It was ordinary New Yorkers and middle-class investors who bore the brunt of the fraud, losing millions of dollars in life savings, said James in a statement.  In a post on X, Gemini stated that the lawsuit “confirms what we’ve been saying all along—that Gemini, Earn users, and other creditors were the victims of a massive fraud,” but that it disagreed with the AG’s decision to also sue Gemini. 
  • CFTC’s Largest Bitcoin Fraud Case Settles for $1.7B. On September 6, a Texas federal judge signed off on a consent order requiring Mirror Trading International to pay over $1.7 billion to settle claims by the CFTC.  The CFTC claimed that the company, run by South African CEO Cornelius Johannes Steynberg, engaged in a fraudulent scheme to solicit $1.7 billion in Bitcoin from Americans for participation in an unregistered commodity pool.  Mirror had advertised that its proprietary trading “bot” would help members achieve profits of 10% per month.  In fact, no such bot existed and the participating Bitcoin was transferred straight to Steynberg’s E-Wallet. 
  • C. Cir. Vacates SEC’s Rejection of Grayscale Bitcoin ETP. On August 29, the D.C. Circuit overturned the SEC’s denial of Grayscale Investment’s bid to turn its Bitcoin trust into an exchange-traded product (ETP).  The three-judge panel found that the Commission had failed to “treat like cases alike” by approving materially similar bitcoin future ETPs but denying Grayscale’s petition.  Absent appeal, the application now returns to the SEC, which will need to decide whether to approve it or to deny it on different grounds. Grayscale has urged the Commission to press forward with an approval, but SEC Chairman Gary Gensler refused to offer any indication as to whether approval would be forthcoming in a recent appearance before the U.S. Senate.

Bankruptcy Litigation

  • BlockFi Begins Post-Bankruptcy Wind-Down. On October 24, crypto platform BlockFi began the process of winding down its operations and repaying its creditors.  The company filed for bankruptcy last November, following the collapse of FTX.  Its Chapter 11 plan was approved on September 23.  BlockFi says that it plans to pursue litigation to recover assets it believes FTX, 3AC, and other companies owe it and distribute assets back to clients.
  • Bankruptcy Judge Signs Off on $175M Genesis-FTX Settlement. On October 6, 2023, New York Bankruptcy Judge Sean Lane approved a settlement between Genesis and FTX that would allow FTX affiliate Alameda Research to receive a $175 million unsecured claim in the Genesis bankruptcy.  The agreement will resolve a nearly $3.9 billion claim brought by FTX and its debtors against the Genesis estate.  Judge Lane said that the agreement would avoid litigation of the FTX claims, which would be “inherently uncertain” and “raise novel legal issues,” given that the defenses available to the Genesis debtors have not previously been addressed in the cryptocurrency context.     
  • FTX Sues SBF Parents for Millions in Damages and Clawbacks. On September 18, FTX, represented by Quinn Emanuel, filed a complaint in Delaware Bankruptcy Court against the parents of former CEO Sam Bankman-Fried seeking to recover millions of dollars in alleged fraudulent transfers.  The complaint alleges that Allan Joseph Bankman and Barbara Fried, both tenured professors at Stanford Law School, “exploited their access and influence within the FTX enterprise to enrich themselves” at the expense of FTX and its creditors.  Bankman and Fried, according to the suit, positioned themselves as corporate insiders and facilitated improper transactions to the family—including a $10 million cash gift and a $16.4 million luxury property in The Bahamas—while the company was on the brink of insolvency. 
  • Bankruptcy Judge OKs FTX’s Crypto Sale Program. On September 13, District of Delaware Bankruptcy Judge John Dorsey approved FTX’s proposal to begin to sell crypto holdings worth around $3.4 billion in order to ultimately pay its creditors.  Under the program, the collapsed company is authorized to sell up to $100 million in cryptocurrency per week and possibly increase that amount to $200 million per week.  Judge Dorsey also approved FTX’s request to hire investment adviser Galaxy Digital Holdings to sell estate assets and engage in hedging transactions. 

Civil Litigation

  • Investors Appeal to Hold Crypto Exchange Accountable for Scam Tokens. A group of crypto investors suing Uniswap filed a notice of appeal to the Second Circuit on September 27, seeking to overturn Judge Katherine Polk Failla’s dismissal of the DeFi platform and its venture capital backers (including Andreessen Horowitz) from their scam token suit.  While sympathizing that the plaintiffs had suffered losses from investing in fraudulent tokens of unknown provenance traded on Uniswap, Judge Failla had held that they could not sue the platform and venture capital defendants in lieu of the actual wrongdoers.  Judge Failla drew a parallel between Uniswap and regular stock exchanges, noting that imposing liability on “those whose role is solely to execute the trades” would be tantamount to inviting stockholders to sue the NASDAQ or NYSE for any undesirable stock purchase.  The proposed class action is one of first impression. 
  • Celebs Urge California District Court to Toss Bored Ape NFT Suit. On September 12, a group of celebrities including Paris Hilton, Jimmy Fallon, Justin Bieber, Madonna, and Kevin Hart filed motions to dismiss a federal suit brought by disgruntled investors in Yuga Labs’ Bored Ape NFTs when the prices of the tokens plummeted.  The investors claimed that, by endorsing the primate-imprinted digital tokens, these celebrities were united in a scheme with Yuga Labs and NFT investment service MoonPay to trick buyers into buying “losing investments at drastically inflated prices.”  Hilton contended that the plaintiffs failed to plead that she even profited from her NFT and that her statement on Fallon’s late night show and subsequent “Loves It!” tweet were nothing but innocuous statements of enthusiasm.  “Celebrities discussing NFTs that they acquired is not securities fraud,” said Fallon’s motion. 

Regulatory and Policy Developments 

  • SEC Chair Gensler Says Crypto Industry “Rife with Noncompliance.” Speaking at the 2023 Securities Enforcement Forum on October 25, U.S. Securities and Exchange Commission Chair Gary Gensler called the cryptocurrency industry “really rife with noncompliance.”  Gensler averred that crypto transactions generally should be subject to securities regulations, stating that “the vast majority of crypto assets likely meet the investment contract test, making them subject to the securities laws.”  The Chair’s statements echoed his previous descriptions of the crypto industry as a Wild West teeming with “hucksters, fraudsters, scam artists, Ponzi schemes.”  
  • Crypto Delistings Hit Record Number. The number of crypto tokens delisted from exchanges hit a record high of over 3,400 this year, according to data compiled by Kaiko.  This is double the amount in 2021, and the highest number since 2016.  Trading on most exchanges has also fallen in the past year, despite over 1.8 million new coins being listed.  Riyad Carey, an analyst at Kaiko, explained that the number of delistings may be the consequence of the “aggressive listing” and resultant explosion of new tokens “during the last bull market,” which have since “faded away or folded in the bear market.”  
  • FinCEN Proposes Reporting Requirements For Crypto Mixers. On October 19, the Treasury’s Financial Crimes Enforcement Network released a notice of proposed rulemaking, unveiling a plan to impose new recordkeeping and reporting requirements on domestic entities engaging in crypto mixer transactions.  The proposed rules are aimed at curtailing money laundering by illicit actors like cyber criminals and terrorist groups, and mark a first-time use of a provision of the Patriot Act that grants the Treasury authority to impose “special measures” on domestic financial institutions upon finding that a class of transactions is of primary money laundering concern. 
  • CA Crypto Licensing Bill Becomes Law. On October 13, California Governor Gavin Newsom signed B. 39, a bill establishing a comprehensive licensing framework for the cryptocurrency industry.  The new Digital Financial Assets Law, effective July 1, 2025, will prohibit crypto traders from engaging in crypto business activity until they are licensed with the state Department of Financial Protection and Innovation.  The law also bars trading of stablecoins except those specifically permitted by the Department, based on its finding that an exemption is “in the public interest.”  The framework follows in the footsteps of New York’s BitLicense scheme, and those already licensed in New York are eligible for a conditional license in California.  Newsom said that the bill will require “further refinement in both the regulatory process and in statute.” 
  • NY Department of Financial Services Proposes New Crypto Listing Standards. The New York State Department of Financial Service (DFS) released a new proposed General Framework for Greenlisted Coins and updated list of pre-approved tokens on September 18.  The proposed framework imposes stricter requirements for coin listings and delistings, including requiring virtual currency entities that wish to self-certify coins outside of the pre-approved list to create a coin-listing policy for DFS’s approval.  In addition, all virtual currency entities that list coins are to implement delisting policies under the new guidance.  The DFS is seeking public comments on the proposal until October 20 but has encouraged entities to start creating delisting policies.  The proposal is part of DFS’s initiative to cement its “role as the leading regulator of virtual currency in the nation.” 
  • Calls to Treat Crypto Traders Like Commodities Traders Under Fed Tax Code. In a September 8 response to a request by the Senate Finance Committee for input on the taxation of digital assets, the American Bar Association Section of Taxation proposed that legislators treat crypto traders like commodities dealers under Internal Revenue Code Section 475,  allowing them to elect to use mark-to-market accounting.  The Section explained that because NFT and crypto traders engage in dealer-like activities in established markets, they too should be allowed to avail themselves of the lower accounting burdens and clear reflection of income that mark-to-market accounting enables.  Joining the call was the Crypto Council for Innovation, which noted in its own letter that this recommendation tracks the Biden Administration’s recent Green Book of tax proposals.