ICO Fraud: SEC Defense Strategies
Introduction
As the use of cryptocurrencies grows in popularity and acceptance by society, investors and businesses are increasingly willing to use initial coin offerings (“ICOs”) to raise capital. An ICO allows individuals to exchange fiat currencies for a coin or token from the offering — an online or digital asset. The investors intend for the value of these coins to go up and provide them with a return on their investment.
Blockchain Team
Blockchain Team Lead & CPA
Blockchain Team
Former U.S. Secret Service Special Agent
With the increase in ICOs comes the higher potential for fraud, market manipulation, and money laundering opportunities. ICO fraud could begin as an internal investigation by the Securities and Exchange Commission (“SEC”) and progress into a criminal prosecution under the authority of the Department of Justice (“DOJ”) or the Federal Bureau of Investigation (“FBI”). Criminal investigations could lead to severe criminal penalties and possibly jail time. If a criminal investigation is started, one must act quickly and retain an experienced federal defense attorney who understands the evolving policy, regulatory landscape, and prevalence of ICOs. An attorney can prepare detailed defense strategies on your behalf to combat ICO fraud allegations.
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Using ICOs to Raise Capital
The SEC has observed that ICOs are being relied on to raise capital or to participate in investment opportunities. ICOs involve the creation of new coins or tokens that are then sold to investors in an offering for fiat currencies. Some advantages of raising capital via ICOs include the following: start-up companies can raise capital faster; investor return on investment may increase if the value of the coins/tokens increases; and capital can be raised without needing to abide by the strict and burdensome regulations typical with traditional financial activities.
Yet while these digital assets offered to the public as well as the underlying technology present new opportunities for conducting business and carrying out financial transactions, they also carry the potential for fraud, money laundering, and market manipulation This is because ICOs and related digital asset activity is less regulated than centralized financial activities and traditional U.S. capital markets.
Regulatory Issues with ICOs
There are many regulatory issues associated with ICOs. To begin with, these events could be deemed securities offerings and therefore fall under the jurisdiction of the SEC. This means that the offering and company issuing the coins/tokens must comply with the federal securities laws, including registration, reporting, and disclosure provisions. In other words, the ICO will need to be registered with the SEC or fall under an applicable exemption. Additionally, the offered coin/token is a “security” for regulatory purposes even if the company issuing it calls it a “coin,” “utility token,” etc. rather than the traditional “stock,” “share,” “bond,” or “investment contract” terms. There are also substantial fraud risks associated with ICOs and a high potential for scam ICOs. Guaranteed returns and payments by credit cards are definite signs of ICO fraud. However, because consistent regulation is scarce, investors may be left with little or no recourse.
Federal Agency Response and Investigations Involving ICO Fraud
Former Chairman of the SEC Jay Clayton has noted in a public statement that ICOs present many new risks and challenges for investors such as whether the offering is legal; is the company issuing the coins/tokens licensed; do investors have any protection; is trading fair; can the market be manipulated; can the investor sell when they want to; what are the hacking and theft risks; etc. In April 2020, the FBI has also responded by using a press release warning of the high potential for ICO fraud as a result of the novel coronavirus. Crime and fraud in the midst of the coronavirus has risen exponentially because criminals are preying on public fear and uncertainty to perpetrate a variety of investment scams. ICO fraud is simple because there are few regulations, everything is conducted online, and international transfers are easy. At the same time, this increased scrutiny from federal agencies exposes start-ups to a high risk of a federal investigation or prosecution for mere instances of noncompliance.
Defense Strategies
Criminal charges involving ICOs may arise from an SEC-initiated investigation. While the SEC does not prosecute criminal cases involving ICO fraud by itself, it will either coordinate the investigative process with other federal agencies or refer the case to the DOJ to pursue criminal charges for ICO fraud. ICO fraud can lead to both civil and criminal penalties. If the federal agency initiates criminal charges, jail time could also be possible. For these reasons, one should retain a defense attorney who is not only experienced in criminal investigations and defense but who also has an intricate knowledge of the ever-expanding crypto sphere—including ICOs.
Defense strategies will vary from case to case and can change based on the stage in the case. A successful criminal defense strategy will raise reasonable doubt about whether the individual committed the securities-related crime such as ICO fraud. Below is a detailed list of defense strategies to combat ICO fraud:
- Challenge the sufficiency of the evidence. Challenging the sufficiency of the evidence in the government’s case file is an important defense strategy. The government has a high burden in criminal cases: proving guilt beyond a reasonable doubt. There can be no ICO fraud if a key element of the offense is lacking. In a criminal case, if the prosecution does not have all the evidence needed to prove every element of the offense, you cannot be convicted.
- Inform your employees and personnel members to only respond to requests for information. Employees and personnel should be informed about the importance of cooperating with federal authorities but should be clear about what can and what should not be discussed with law enforcement and federal agencies during an active investigation.
- Conduct an internal audit. Internal audits can help you and your company determine what federal agencies are seeing or may see upon further investigation. These audits may also reveal whether there are any false or misleading materials in the information given to investors involving the ICO.
- Argue that the ICO has complied and does comply with U.S. securities laws. If the ICO has fully complied with the securities laws, the prosecution will struggle to argue fraud. It is important to have accurate and detailed records of the planning process, filings, and all investor disclosures relevant to the ICO.
- Determine whether the company can implement any corrective action plan. A corrective action plan should be implemented when instances of noncompliance are discovered. This demonstrates to federal authorities the intent to maintain full compliance with the law.
- Work with your defense attorney to develop a detailed and personalized defense strategy. Securities law violations are often very detailed and complex. This is especially true of ICOs in recent years. Your attorney will gather all details and evidence for your case and immediately work on developing a comprehensive defense strategy that considers all possible future scenarios.
- Refuse to give information to law enforcement or federal agencies without speaking to your attorney. You are perfectly within your rights to inform law enforcement and federal agencies that you want to wait and discuss all matters with your attorney first. Remember that federal agencies can use anything you say and do against you. Do not give them this opportunity.
- Decide which defense position to take. After developing a defense plan, your defense attorney will then execute it. Along with carrying out a well-defined defense strategy, your attorney will help you decide whether the facts of your case warrant a collaborative approach or an aggressive one as well as whether settlement is possible or whether trial preparations are needed.
Conclusion
ICOs are a recent phenomenon that has allowed start-ups to raise capital quickly without all the reporting and disclosure obligations of traditional offerings. But with this lack of regulation comes an increased potential for fraud. ICOs present a host of challenges for investors including whether they can sell the coin/tokens purchased from the offering; whether the federal securities laws will provide them with relief; or whether the ICO is an investment scam. Because of all the uncertainty, federal agencies have increased their investigations and prosecutions of ICO fraud. Investors need to take a proactive approach by retaining a defense attorney who can determine your role in the government’s investigation, assess your criminal liability exposure, and develop a personalized defense strategies designed to give you the best chance of a favorable outcome.
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