SEC Files Securities Fraud Claims Against Bitcoin Mining Companies

Targaryen (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsThe U.S. Securities and Exchange Commission (SEC) is charged with enforcing federal laws against securities fraud, which includes a constantly expanding range of activities. In late 2015, the agency turned its attention to Bitcoin, a virtual payment system that has been the subject of much attention and controversy in recent years. Bitcoins have no physical, tangible form. Instead, they exist as a series of complicated computer transactions and calculations. It is possible to create new Bitcoins by assisting in processing Bitcoin transactions, a process known as “mining.” The SEC filed a civil complaint in late 2015 against two companies engaged in Bitcoin mining, alleging violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. SEC v. Garza, et al, No. 3:15-cv-01760, complaint (D. Conn., Dec. 1, 2015). Although the suit is civil, not criminal, it offers an idea of how financial regulators may approach cases that add elements of cyber crime to securities law.

Federal securities laws regulate the issuance, sale, and exchange of a wide range of intangible assets. The Securities Act and the Securities Exchange Act use similar definitions of “security,” which include familiar items like stocks, notes, bonds, treasury bills, and futures, as well as various other types of investments. 15 U.S.C. §§ 77b(a)(1), 78c(a)(10). Bitcoin is a new, and still relatively unfamiliar, technology, but the SEC is viewing the assets involved in this case as “investment contracts.” Garza, complaint at 1.

Speaking very generally, the Securities Act prohibits fraudulent activities in connection with the issuance of securities, and the Securities Exchange Act prohibits fraud in their secondary sale or exchange. The SEC alleges, however, that the defendants engaged in a typical type of fraud, albeit one “cloaked in technological sophistication and jargon.” They allegedly “sold what they did not own, and misrepresented the nature of what they were selling.” Id.

Bitcoin was created in 2009 as a “cryptocurrency,” a term that refers to various virtual or digital currencies that are not tied to any particular country. Many merchants accept Bitcoins as payment, especially on the internet. Some people also treat Bitcoin as an investment, tracking the price of Bitcoins in U.S. dollars.

The Bitcoin system is based on a worldwide network of computers, which uses complicated calculations known as block chains to process and record Bitcoin transactions. “Mining” Bitcoins involves contributing computer resources to assist in processing Bitcoin transactions. Users are rewarded for this with “new” Bitcoins. According to the SEC’s complaint, the defendants sold investment contracts called “Hashlets,” which they said represented a share of returns from Bitcoin mining operations. Garza at 2.

Performing the calculations required for Bitcoin mining requires a significant amount of computing power. The defendants allegedly obtained about $19 million from the sale of Hashlets to more than 10,000 investors. The SEC claims, however, that they “sold far more Hashlets worth of computing power than they actually had in their computing centers,” and that they lacked the “computer equipment to back up the vast majority of Hashlets that [they] sold.” Id. The SEC’s complaint alleges violations of § 10(b) and Rule 10b-5 of the Securities Exchange Act, 15 U.S.C. § 78j(b), 17 CFR 240.10b-5; and §§ 5(a), 5(c), and 7(a) of the Securities Act, 15 U.S.C. §§ 77e(a), (c), 77q(a).

These blog posts are meant to be illustrative only. Unless expressly stated to the contrary herein, these matters are not the result of any legal work of Michael J. Brown, but are used to communicate a particular point of view. Michael J. Brown does not claim credit for any legal work done by any lawyer or law firm either generally or specifically, with respect to the matters contained in this blog.

Michael J. Brown, a Board-certified cyber crime attorney, has fought for over 20 years for the rights of individuals in West Texas charged with alleged state and federal white-collar offenses. Contact us online or at (432) 687-5157 today to schedule a confidential consultation with a knowledgeable advocate for criminal justice.

More Blog Posts:

How Clearing One’s Browser History Might Be a Federal Crime, Texas Criminal Lawyer Blog, January 6, 2016

Personal Use of Corporate Credit Cards Results in Wire Fraud Charge in Federal Court, Texas Criminal Lawyer Blog, October 30, 2015

Nine People Indicted for Alleged Insider Trading, Using Information Allegedly Obtained by Hacking, Texas Criminal Lawyer Blog, October 30, 2015

Photo credit: Targaryen (Own work) [CC BY-SA 3.0], via Wikimedia Commons.