Dept of Justice, US Attorney’s Office for the Eastern District of New York, Brooklyn, NY

United States District Court for the Eastern District of New York (Brooklyn)

USA v Zaslavskiy, 1:17-cr-00647-RJD-RER

Synopsis of Crypto Criminal Action by the DOJ:

Note: As a precedent to this action, on September 29, 2017, the SEC filed an emergency injunction civil action in the United States District Court for the Eastern District of New York against defendants, REcoin Group Foundation LLC (“REcoin”), DRC World Inc., a/k/a Diamond Reserve Club (“Diamond”), and Maksim Zaslavskiy (“MZ”). (the ‘Civil Action’)

On November 21, 2017, the US Attorney’s Office for the EDNY filed in the Court a 13 page grand jury Indictment comprising three counts against MZ:

Background Briefly: If It Barks, It’s A Dog

The defendant stated in the Motion to Dismiss that the REcoin and DRC coins in the virtual ecosystem were intended to function as virtual currencies as both a medium of exchange and a store of value, thereby improving transaction efficiencies. For example, the REcoin could be used as a transfer of value between an architect and a property owner via a smart contract function recorded on the ecosystem blockchain. However, upon realization that this model was not going to be successful, the defendant stated that they refunded almost all of the money back to the investors.

Thereafter, the defendant promoted the DRC ecosystem with an alternative financing method using IMO tokens hedged by diamonds as the asset. Since the SEC had first come calling in August, 2017, it was alleged that the defendant just substituted membership for a coin token, and hence the defendant’s ‘Initial Membership Offering’ was born (IMO).

Well, that certainly was creative!  But, in our opinion, if it barks, its a dog, no matter the last minute creative breed name, size or color used for promotion.  Certainly, the SEC bloodhounds were not sidetracked and did not loose the scent.

Three-Count Indictment:

The three count Indictment from the Grand Jury states substantially as follows:

Count One: Conspiracy to Commit Securities Fraud

The defendant with others did knowingly and willfully (a) employ schemes to defraud, (b) make untrue or misleading statements of fact, and (c) engage in fraud and deceit upon investors by interstate commerce and the mails, all in violation of 15 USC Sections 78j(b) [Manipulative and Deceptive Practices] and 78ff [Penalties], and 17 CFR 240.10b-5.

Count Two: Securities Fraud re REcoin

The defendant with others did knowingly and willfully (a) employ schemes to defraud, (b) make untrue or misleading statements of fact, and (c) engage in fraud and deceit upon investors by interstate commerce and the mails, all in violation of 15 USC Sections 78j(b) and 78ff; 18 USC Sections 2 and 3553 et seq., and 17 CFR 240.10b-5.

Count Three: Securities Fraud re Diamond

The defendant with others did knowingly and willfully (a) employ schemes to defraud, (b) make untrue or misleading statements of fact, and (c) engage in fraud and deceit upon investors by interstate commerce and the mails, all in violation of 15 USC Sections 78j(b) and 78ff; 18 USC Sections 2 and 3553 et seq., and 17 CFR 240.10b-5.

Plus a Criminal Forfeiture Allegation

That upon conviction of any of the offenses, the defendant shall forfeit all proceeds derived from said offenses, and if any such proceeds have diminished in value, the property of the defendant shall be forfeited as the make-up value, citing 18 USC Section 981(a)(1)(C); 21 USC Section 853(p); and 28 USC Section 2461(c).

Key Court Dates and Proceedings – USA v Zavlaskiy

On January 31, 2018, the Court granted the Motion by the SEC to Intervene and Stay the Proceedings in the Civil Case, pending resolution of this criminal case.

On February 27, 2018, the defendant filed a Motion to Dismiss the indictment for lack of jurisdiction stating the proposition that cryptocurrencies were exempt from securities regulations as currencies because they did not represent investment contracts, and therefore securities, within the meaning of the statutes. In addition, 15 U.S.C. §78j(b) and 78ff, as applied to cryptocurrencies, was void due to unconstitutional vagueness.

The defendant briefed three ‘facts vs law’ arguments at length reviewing why the indictment was inadequate on its face:

• Currency Not Securities: Issue of fact – That the offered tokens were currency and not securities, and currencies were specifically exempt by statute from being considered securities, citing 15 U.S.C. § 78c(a)(10) (“The term ‘security’ means . . . but shall not include currency”).
• Investment Contracts Not Securities: Issue of fact – That cryptocurrencies were not “investment contracts” and therefore not securities within the meaning of the law as all three elements of the Howey test (SEC v. W.J. Howey Co..et al., 328 U.S. 293, 1946 > abbv. a. investment of money b. common enterprise c. profit from the efforts of others) were not present; and
• Statutes Unconstitutionally Vague: Issue of law – That the Securities statutes were unconstitutionally vague as to what constituted an “investment contract” pursuant to the 1933 and 1934 Securities Acts, and emphasized that no court had written an opinion on how the third prong of the Howie test applied to decentralized cryptocurrencies.

Although the three arguments by the defendant were to attack the Indictment on its face, the first two were sufficient as the indictment was only plead in terms of the federal Securities laws and would be decided on issues of fact at trial. The purpose of the third argument, alleging that the same Securities laws where unconstitutionally vague re cryptocurrencies, is that constitutionality must be decided as a matter of law. Thus, if unsuccessful at the criminal trial on the facts, the defendant would have an secondary avenue, arguing unconstitutionality of the statutes as a matter of law, to the United States Court of Appeals for the Second Circuit, and ultimately the Supreme Court of the United States, to nullify an unfavorable verdict of a criminal trial.

On March 19, 2018, both the USA and the SEC filed individual Memoranda in Opposition to the defendant’s Motion to Dismiss.

On March 26, 2018, the defendant filed a Response and supporting Memorandum.

On May 8, 2018, oral argument by the parties was heard by Judge Raymond J. Dearie.

On September 11, 2018, Judge Dearie denied the Motion to Dismiss in that the Indictment as plead met the legal requirements, and that the statute was not unconstitutionally vague as applied. The case was ordered to proceed to trial.

The detail of Judge Dearie’s decision will be reviewed in a subsequent post.

January 7, 2019 – pending trial date.

Stay tuned.

Commentary by Attorney Timothy F. Mills, Editor / Action Cyber Times™ © 2018 All Rights Reserved.

Action Cyber Times™ provides resources for cybersecurity, data privacy, compliance, breach reporting and risk management, intellectual property theft, and the utilization of emerging technologies such as artificial intelligence, machine learning, blockchain DLT, advances in cryptographic applications, and more.

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