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Investor Recourse for Initial Coin Offering Fraud


December 12, 2017

Investor Recourse for Initial Coin Offering Fraud

With the price of Bitcoin rising and blockchain technology gaining increasing legitimacy, Initial Coin Offerings (ICOS) are gaining popularity with investors. However, as highlighted by two recent SEC enforcement actions, ICOs are extremely risky investments and in some cases, may be completely fraudulent. In such cases, private investors have available remedies that include prosecuting their own lawsuits alleging fraud and even Civil RICO claims where a pattern and other requisite facts can be alleged.

Investor Recourse For Initial Coin Offering Fraud

Photo courtesy of Volkan Olmez (Unsplash.com)

SEC Brings Two ICO Enforcement Actions

As more fully discussed in a prior article, businesses are increasingly using initial coin offerings, also called token sales, to raise capital. Virtual coins are created and disseminated using distributed ledger or blockchain technology. Purchasers may use U.S. dollars or virtual currencies to purchase virtual coins or tokens. 

The profits of ICOs may be used to fund the development of a digital platform, software, or other projects. In addition, investors may use the virtual tokens or coins to access the platform, use the software, or otherwise participate in the project. After they are issued, the virtual coins or tokens may also be resold to others in a secondary market on virtual currency exchanges or other platforms. 

The Securities and Exchange (SEC) recently brought enforcement actions against two companies for defrauding investors in ICOs purportedly backed by investments in real estate and diamonds. According to the agency, Maksim Zaslavskiy and his companies lured investors by touting a novel technology that would deliver substantial returns. However, the digital coins didn’t really exist.

According to the SEC’s complaint, investors in REcoin Group Foundation and DRC World (also known as Diamond Reserve Club) were promised sizeable returns from the companies’ operations. However, neither company had any real operations.

Zaslavskiy allegedly touted REcoin as “The First Ever Cryptocurrency Backed by Real Estate.”  Although he also told investors that the company had a “team of lawyers, professionals, brokers, and accountants” that would invest the ICO proceeds into real estate, none had been hired or even consulted. Zaslavskiy and REcoin also allegedly misrepresented that they had raised between $2 million and $4 million from investors when the actual amount was approximately $300,000.

According to the SEC’s complaint, Zaslavskiy used his Diamond Reserve Club to execute a similar fraud. Zaslavskiy represented to investors that the company invests in diamonds and obtains discounts with product retailers for individuals who purchase “memberships” in the company. In reality, the SEC alleges that Zaslavskiy and Diamond have not purchased any diamonds nor engaged in any business operations.

Based on the false representations and the sale of unregistered securities, the SEC is seeking permanent injunctions and disgorgement plus interest and penalties. For Zaslavskiy, the SEC also seeks an officer-and-director bar and a bar from participating in any offering of digital securities.

Remedies for Investors Defrauded in Coin Offerings

Defrauded ICO investors will have viable claims, with the biggest obstacle to actual recovery of their losses being finding recoverable assets.  While some investments are governed by federal securities laws, most ICOs are not regulated and/or are based overseas. So when something goes wrong, following the money and tracing the assets or the fraudsters after obtaining a judgment is the required effort if no settlement is negotiated.

As the SEC highlighted in a recent Investor Alert, third-party wallet services, payment processors, and virtual currency exchanges that are involved in the use and exchange of virtual currencies may also be located outside of the United States or be operating unlawfully. In addition, regulators and law enforcement agencies face a range of challenges in investigating ICO fraud. As detailed by the SEC, they include:

  • Tracing money: Traditional financial institutions (such as banks) often are not involved with ICOs or virtual currency transactions, making it more difficult to follow the flow of money.
  • International scope: ICOs and virtual currency transactions and users span the globe. Although the SEC regularly obtains information from abroad (such as through cross-border agreements), there may be restrictions on how the SEC can use the information and it may take more time to get the information.  In some cases, the SEC may be unable to obtain information from persons or entities located overseas.
  • No central authority:  As there is no central authority that collects virtual currency user information, the SEC generally must rely on other sources for this type of information.
  • Freezing or securing virtual currency: Law enforcement officials may have difficulty freezing or securing investor funds that are held in a virtual currency.  Virtual currency wallets are encrypted and unlike money held in a bank or brokerage account, virtual currencies may not be held by a third-party custodian.

For investors, there are several steps that you can take to increase the chances that you may recover some of your investment losses. For instance, it is imperative to report the fraud to state and federal securities regulations as soon as you suspect something is wrong. This could be important to enable a freeze on assets before they are transferred. In most cases, scammers will quickly try to cover their tracks. Defrauded investors should consult with experienced counsel as soon as possible. A knowledgeable attorney can help determine whether any securities laws were violated and take steps to pursue all available legal remedies. I have successfully pursued civil RICO claims, and I found the treble damages and recoverable legal fees provisions authorized for civil RICO claims helpful in negotiating the settlement of civil RICO claims.

Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Dan Brecher, at 201-806-3364.

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