Category: Fraud

Cryptocurrency Problems Roundup

Crypto Currency can be a Commodity

A federal judge in Massachusetts agreed with the Commodity Futures Trading Commission’s view that virtual currencies are commodities under the Commodity Exchange Act and subject to federal regulation. See CFTC v. My Big Coin Pay, Inc., (D. Mass. Sept. 26, 2018). The CFTC sued a virtual currency company and several affiliated companies and individuals alleging fraud and misappropriation in the sale of the virtual currency “My Big Coin.” The CFTC claims that defendants perpetrated the fraud by falsely representing to purchasers that My Big Coin was “backed by gold,” could be used anywhere Mastercard was accepted, and was being “actively traded” on several currency exchanges.

My Big Coin Pay is the second federal court decision to embrace that virtual currencies are commodities under federal law. In CFTC v. McDonnell, (E.D.N.Y. Mar. 6, 2018), the court found that the term “commodity” encompasses virtual currency “both in economic function and in the language of the statute” because virtual currencies are “‘goods’ exchanged in a market for a uniform quality and value.”

Unregistered national securities exchange

The SEC brought its first enforcement action against a cryptocurrency trading platform for operating as an unregistered national securities exchange. EtherDelta is an online platform for secondary market trading of ERC20 tokens used by Etherium based crypto. Over an 18-month period, EtherDelta’s users executed more than 3.6 million orders for ERC20 tokens, including tokens that are securities under the federal securities laws. Almost all of the orders placed through EtherDelta’s platform were traded after the Commission issued its 2017 DAO Report, which concluded that certain digital assets, such as DAO tokens, were securities and that platforms that offered trading of these digital asset securities would be subject to the SEC’s requirement that exchanges register or operate pursuant to an exemption. EtherDelta offered trading of various digital asset securities and failed to register as an exchange or operate pursuant to an exemption.

The Environment

If you’re an environmentalist you also need to think about the energy of cryptocurrency mining. The amount of energy required to “mine” one dollar’s worth of bitcoin is more than twice that required to mine the same value of copper, gold or platinum.

You Can’t Hide Overseas

The Tezos blockchain project established a Swiss non-profit stiftung to oversee the ICO and control the proceeds. No surprise that the ICO was bad for those who bought and they a class action. The court found the tokes to be securities. The meant the sale was an unregistered security transaction. The only question was whether the ICO and its sponsors were subject to US securities laws.  The court listed several factors that contributed to its determination that the sale of Tezos tokens had occurred in the United States, including that:

  • US investors bought Tezos tokens
  • a website that sold the tokens was hosted in the US and run by a person located in the US
  • marketing efforts targeted US residents
  • payments made in Ether for the Tezos tokens were validated by a network of Ethereum nodes clustered more densely in the US than in any other country.

Unregistered Broker-Dealer

The Securities and Exchange Commission imposed sanctions against TokenLot LLC, an “ICO Superstore,” for its sales of digital tokens to the general public through a website. The SEC found that TokenLot acted as unregistered broker-dealers in violation of Section 15(a) of the Securities Exchange Act of 1934 and engaged in unregistered securities offerings in violation of Section 5 of the Securities Act of 1933.

Summary

It’s clear the SEC and CFTC have some easy targets in ICOs and their sponsors. I expect there are many more cases in the pipelines.

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Blockchain Exchange Commission

Worried about the security of your cyptocurrency? How about having the Blockchain Exchange Commission protect you.

It won’t.

According to a complaint filed by Securities and Exchange Commission, Reginald Ringgold is a founding member of this very prestigious-sounding, regulatory-sounding Blockchain Exchange Commission. According to it’s LinkedIn page:

The mission of the [Blockchain Exchange Commission] is to protect investors; and assist in maintaining fair, orderly, and efficient markets within the Blockchain Digital Asset Space. The [Blockchain Exchange Commission] strives to promote a market environment with Decentralized Governance and reliance on distributed ledgers rather than internal ledgers that can exploit the public’s trust.

You might want to compare that to the What We do Page on the SEC’s website:

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

Even more fun, the BEC lists it’s address on LinkedIn as 100 F Street NW in Washington D.C. You may know that better as the SEC headquarters.

It looks like the BEC has cleaned up its website, removed its claims of investor protection and stated its address in San Diego.

The information about the BEC came out in an SEC complaint against Blockvest and its founder, the same Reginald Ringgold.

“Don’t look for the needle in the haystack…just buy the whole haystack.” – Reginald Ringgold

The SEC won’t approve Bitcoin ETFs, so Blockvest is creating a token as a fund. The offering is some pool of something that does something, blockchain, blockchain… The whitepaper is a bunch of nonesense.

The Securities and Exchange Commission obtained an emergency court order to halt a planned initial coin offering of Blockvest, which falsely claimed that it was approved by the SEC. The order also halts ongoing pre-ICO sales.

There is no bigger red flag than stating that an offering is approved by the SEC.

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“Crypto is the Mother of All Scams”

It looks like the testimony will not be subtle at the Senate Banking Committee today entitled: Exploring the Cryptocurrency and Blockchain Ecosystem.

Peter Van Valkenburgh, Director Of Research at Coin Center, spends his time trying to explain blockchain by calling it decentralized computing. I’m going to guess that his presentation falls on ears that have no idea what he’s talking about.

Nouriel Roubini, Professor of Economics at the Stern School of Business at New York University, is much less subtle. He titles his testimony:
Crypto is the Mother of All Scams and (Now Busted) Bubbles While Blockchain Is The Most Over-Hyped Technology Ever, No Better than a Spreadsheet/Database.

Actually calling this useless vaporware garbage a “shitcoin” is a grave insult to manure that is a most useful, precious and productive good as a fertilizer in agriculture.

He goes on to attack the premise of cryptocurrency. Financial crises happened before fiat currencies and central banking. There were many bubbles and busts before central banking. We all note tulipmania. He takes the position that central banking helps avoid currency runs that occur when a bubble bursts. It may be hard to make this point when the wounds of the 2008 financial crisis still feel fresh.

Professor Roubini also points out the environmental consequences of cryptocurrency. He cites a figure of $5 billion a year spend on energy costs.

My personal take on bitcoins and other cryptocurrency is that they have been a boon to criminals and money laundering. The loose attitude for the exchanges on reporting suspicious transactions has been a boon for moving illegal money around from person to person and laundering it back into the legitimate money system.

Then add in the pump and dump mechanisms of other smaller coin ecosystems, you have fraudsters getting money from ICOs. More money when they fraudulently prop them up, then use them to transmit the proceeds outside the legitimate banking system.

Last night, the International Monetary Fund warned that cryptocurrencies “could create new vulnerabilities in the international financial system.” Cryptocurrency valuations crashed as a result.

You can also add in the “whales” of Bitcoin when talking about stability. Thirty-two Bitcoin wallets collectively own about 1 million bitcoin (i.e 5% of all bitcoins). Five of those wallets are lost. The owner lost the private key and cannot access the accounts. That represents 212,000 coins worth about $1.3 billion. That to me, is an incredible concentration in ownership that can’t lead to anything good.

All You Wanted to Know About SEC Remedies

Steven Peikin, Co-Director of the SEC’s Division of Enforcement gave an encyclopedic description of the Remedies and Relief in SEC Enforcement Actions at PLI’s White Collar Crime symposium. The speech was meant to address the effectiveness of enforcement actions. He wanted to point out that the number of enforcement actions or the total amount of penalties are not good metrics for assessing the work of the enforcement division.

The speech looked at all of the remedies available and how they address the mission of the Securities and Exchange Commission.

Undertakings – Specifically target and attempt to address specific risks

He gave the example of Tesla and Elon Musk. The undertaking to control Musk’s corporate communication was to address the “the potential harm to investors caused by Musk’s communication practices and a lack of sufficient oversight and control of those communications.”

Bars and Suspensions – serve a critical prophylactic function

They preserve the integrity of the markets and protect investors by limiting the activity of known bad actors by removing them from the industry or preventing them from serving as officers or directors at public companies.

Penalties – serve as a deterrent

“Penalties are one of the primary enforcement tools we have to incentivize regulated entities to remain in compliance with the rules that protect investors.”

Disgorgement – Even where a defendant “cooperates and agrees to meaningful undertakings, it should not be entitled to keep its ill-gotten gains, which we are often in a position to restore to harmed investors.”

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If Your Clients Are Going to Lose Money Anyway, Why Not Just Steal It?

Say you run a trading platform and lots of your traders lose money. Why not just take their money for yourself instead of them losing it to the market?

For one, that’s stealing.

But apparently that didn’t stop Jeffrey Goldman, Naris Chamroonrat, Christopher Eikenberry, Ran Armon, Adam Plummer, and Yaniv Avnon from doing just that.  They set up Nonko Trading as a purported offshore proprietary trading firm. It was organized to cater to U.S.-based day-traders, but evading the U.S. Broker-Dealer registration and regulatory requirements.

The Nonko group interviewed traders first. They targeted traders that appeared inexperienced or unsophisticated. Instead of providing these traders with access to a live securities trading platform, the Nonko team provided them with training accounts that merely trading.  When these traders sent funds to Nonko to place securities trade orders, the orders were never actually sent to the markets. Instead, the Nonko team simply pocketed the traders’ money.

Their theory is that the traders won’t notice that you stole their money if they were going to lose it anyway. If you’ve see The Producers you know how this works. Your targets won’t know you’ve stolen you money if the targets thought they lost it.

If a trader stated to make money, they moved that trader from the simulation on the TRZ platform to the live NTRD version of the platform.

The Nonko crew apparently left a trail of messages pointing out their misdeeds”

the current frame work [sic] now with TRZ is that we interview the
traders first and make sure they are complete newbs before putting
them on TRZ, while at the same time, we have a close watch to see
which account is starting to make money, at any point in time they
start to show signs of profitablity [sic] we quickly switch them
over to a NTRD account (live)
with this new platform, we will use the same process but as we
expect to have smaller deposits and more new accounts, we will
have to figuire [sic] a more stricter way to flag “game” accounts,
we havent [sic] gotten that far yet

The Nonko Group lured day traders by offering high margin limits (20:1) and small commissions. They also put together written TRZ Guidelines on which traders should be selected for the fraudulent TRZ platform.

During the initial phases of the training accounts scheme, Goldman commented to Chamroonrat on Skype: “trz group down 3k…every trader down. How come part of me feels good and part of me feels bad?!?!??”

You feel bad, because you’re stealing their money.

In The Producers, the scheme goes awry when the production makes money. For Nanko, it went wrong when a newbie trader on the TRZ version called the underlying provider for technical help. The help desk was confused that the trader thought his simulation was real. Once the provider saw the problem it emailed all of the TRZ traders telling them it was just a simulation.

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Broken Windows at Wells Fargo

Getting a free meal is one of the few perks of staying late at the office for many financial services firms. The firm is willing to pay some set amount if the employee stays after some deadline. Most figure that the person is going to be more productive if he or she is not starving.

I initially found it strange that Wells Fargo fired a dozen employees of the Wells Fargo Securities division for violating the policy.

Wells Fargo has been in the news for all the wrong reasons. My first reaction is that it was taking the broken windows approach: target small crimes to create an sense of order and compliance as a deterrence to bigger problems. What could be a smaller crime than ordering a free dinner before the 6:30 dinner policy time? You get hungry at 6:15 and order, knowing that it will take time to get delivered and that you are planning to work for another few hours.

Did Wells Fargo really bring down the hammer for ordering dinner early?

I don’t think so.

The employees that were fired were accused of altering their receipts to show an order time in compliance with the policy. The headlines were missing the point.

Wells Fargo fired a dozen employees for forgery. It was stupid forgery. These bankers could afford the $20 for dinner. Something was wrong with the culture if employees feel that forgery is acceptable.

If you remember back to the bigger problems at Wells Fargo, employees were forging account opening documents to meet their sales quota. That is clearly a bigger problem than the $20 dinner receipt. But a financial firm cannot tolerate any level of forgery.

The fired employees must feel stupid. Losing a job over not wanting to pay for cheap sushi is a terrible way to start a career.

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2018 Global Study on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners

Study 2,690 cases of occupational fraud over 18 months and you may see some trends. The Association of Certified Fraud Examiners conducted a survey of its 41,000+ certified fraud examiners to collect data on the single biggest fraud case they investigated from January 2016 to October 2017.

The study identified six behavioral red flags that have consistently been common in each of its studies (ranked by prevalence):

  1. Living beyond means (41%)
  2. Financial difficulties (29%)
  3. Unusually close association with vendor/customer (20%)
  4. Control issues/ unwillingness to share duties (15%)
  5. Divorce or family problems (14%)
  6. “Wheeler-Dealer” attitude involving shrewd or unscrupulous behavior (13%)

According to the report, the fraudster displayed at least one of these red flags in 86% of the cases and displayed more than one in 50% of the cases.

The other piece of data that jumped out at me was that employees who been with their company longer stole more. Setting the line at five years of tenure at the job, those with more stole a median of $200,000 and those with less stole $100,000.

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The One With the Whale Whisperer

Often there is little new to discover and learn from in securities fraud charges. The fraudster may or may not have started with good intentions. Regardless, the fraudster takes the investors’ money and spends it on things it was not supposed to be spent on. But I could not help but take a closer look at the securities fraud case where the fraudster is identified as the “whale whisperer.”

At first, I thought the case might have involved JP Morgan’s London Whale who lost the firm $6.2 billion. But it turned out to be a much more colorful character.

Paul Gilman is a New Age composer, rock music producer, and filmmaker. He made a film about using music to communicate with ocean mammals. He apparently had some solid technical skills and upgraded the sound systems for the Houston Astros and the Texas Rangers at their stadiums. He leveraged that into convincing investors to give him more capital for more installations.

He had some idea that he could use sound to lower the viscosity of oil, allowing it to flow through pipelines more efficiently. (That sounds like a evil villain plan to gain entry to an industry, then decimate others with soundwave technology.) He convinced investors to give him capital to test and develop this purported technology.

I don’t know if Mr. Gilman thought he could expand his stadium sound business and develop his oil viscosity sound system or whether he started out intending to steal people’s money. He did not agree to the charges and pleased the Fifth Amendment.

Regardless of his original intent, he did what most frausters do in the end. He spent investors’ money on his own needs instead of the company needs. The SEC points out that he spend the investors’ money on designer clothing, travel and dining, rent and home furnishings, and cash withdrawals at casinos.

In the complaint, the SEC piles on and tells the stories of a nurse in Dallas, a church minister in Tennessee and psychology professor in Houston who “invested” money in Gilman’s enterprises.

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HoweyCoins – The ICO I Have Been Waiting For

Initial coin offerings have been a new wave of financing.. and scams. One offering that you should look at for some lessons about coin offerings is the soon to be released Howey Coin.

HoweyCoins are the cryptocurrency for the travel industry. According to the white paper, HoweyCoins partner agreements lock in an average initial discount of 30% for airfare and 42% for hotel room rates for all HoweyCoin-denominated transactions. The agreements are not final, but once the offering is complete, they will be revealed.

This is a can’t miss investment opportunity. HoweyCoins are officially registered with the U.S. government and will trade on an SEC-compliant exchange where you can buy and sell them for profit. According to the ICO team, they “forecast a minimum growth rate of between 7% to 15% annualized, making HoweyCoins attractive for long-term investment. In addition, HoweyCoins can serve as a GUARANTEED hedge against inflation and market loss.”

…

Hopefully, you have noticed a few things that might make you not click on the the button to buy the HoweyCoins. Bonus points if you recognized “Howey” as the seminal court case that sets the test for whether an investment is a security. Hopefully you noticed the “registered with US government” as red flag that this company is doing something wrong with this offering. Of course the high returns, and guarantee of success are hallmarks of problematic offerings. But if not, go ahead and click on the button.

This is a new type of performance education by the Securities and Exchange Commission. Clearly, the SEC is focused on the fraud and securities-law violations of coin offerings. If you are involved in such an offering, you should be worried. The SEC spent some time, money and energy on putting together the HoweyCoins website. You can be certain that the SEC is devoting much more time, energy and money into investigating ICO fraud and securities law violation.

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Fraudulent Coin Offerings

I’ve been highly critical of cryptocurrency. It doesn’t act like a currency: people are not using it to actually buy goods and service (at least not legal goods and services).  The world of coin offerings has been the wild west. In many instances, the sponsors are just ignorant of the securities law implications of their coin offering structures. Others are scams or turn quickly into scams.

The most recent coin offering to come crumbling down is the CTR Token sponsored by CentraTech. The SEC charged Sohrab Sharma and Robert Farkas with masterminding the fraudulent Initial Coin Offering.

What was the case for using Centra? I read through the whitepaper and it’s full of nothing. There is some nonsense abut currency conversion and storing coins in the Centra Wallet. As near as I can tell the only thing Centra Token did was get the boxer Floyd Mayweather to endorse it.

Centra Tech claimed that it was producing a debit card backed by Visa and MasterCard that would allow you to instantly convert hard-to-spend cryptocurrencies into U.S. dollars.  The SEC alleges that Centra had no relationships with Visa or MasterCard.

Sharma and Farkas stated that funds raised in the Initial Coin Offering would help Centra Tech build a suite of financial products. This turned it into a securities offering because the offering claimed that token holders would be paid “rewards” of 0.8% of the total revenue that Centra earned from Centra Card transactions. That makes the ICO a securities offering.

This goes back to the Howey definition of a “investment contract” as “investment in a common enterprise with the expectation of profit to be derived through the essential managerial efforts of someone other than the investor.” If it meets the definition of “investment contract” its a security.

“Endorsements and glossy marketing materials are no substitute for the SEC’s registration and disclosure requirements as well as diligence by investors.” – Steve Peikin, co-director of the SEC’s Division of Enforcement.

My Favorite part of the fraud is the use of fictional executives. “Michael Edwards” was listed as the Chief Executive Officer and Co-Founder of Centra, with an impressive LinkedIn profile. He had an M.B.A. from Harvard University and an extensive career in banking, most recently as a Senior VP at Wells Fargo. Edwards was not a real person. A photo of Edwards used in an early version of Centra’s website was that of a Canadian professor of Physiology and Pathophysiology with no relationship to the company. Later versions of the marketing materials included instead a picture of one of Defendant’s relatives purporting to be of “Edwards.”

The big surprise is that it took the SEC this long to build a case. The New York Times put together a profile of the company in October that was full of red flags.

Several weeks ago Sharma and Farkas received subpoenas from the SEC about the Centra ICO.  I would assume that they realized their time was short. According to the SEC’s complaint, Farkas made flight reservations to leave the country around April 1. That must be what put the SEC and the Department of Justice on an accelerated schedule. Farkas was arrested before he was able to board his flight.  Sharma was also arrested.

As of March 30, Centra’s bank accounts were depleted and most of its employees had been terminated according to the SEC complaint.

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