Originally published on April 4, 2018
GOT THE SUITCASE UP IN THE CENTRA — ICO Co-Founder Arrested at the Airport
And, it’s getting serious! The SEC is no longer just forcing ICO issuers to return the purchaser’s money, now people are actually getting arrested for securities fraud. The two Centra Tech Inc. (“Centra”) ICO co-founders were arrested on April 1, one of them was at the airport trying to flee the country when the Dept. of Justice tracked him down.
See SEC Press Release: https://www.sec.gov/news/press-release/2018-53
Their fundraising endeavors began in Pre-sale on July 5, 2017, and the Initial Coin Offering (“ICO”) took place between July 30, 2017 and October 5, 2017. Notably, the first SEC comments or warnings that ICO’s may be considered securities happened on July 25, 2017 with the DAO notice. Centra raised at least $32 million from thousands of investors across the world, and the SEC refers to the capital influx as Centra’s “sale of unregistered securities.” The Centra Token was an ERC 20 Token, sold on the Ethereum Blockchain, pumped as a revolution in financial technology backed by Visa, Mastercard and Bankcorp to allow users to spend their crypto with traditional plastic.
The Sale of Unregistered Securities:
The sale of unregistered securities (doing an ICO without registering it with the SEC or filing for an exemption from registration such as Regulation A+ or Regulation D, and limiting the sale to Accredited Investors) opens the door to criminal prosecution when there is fraud involved. The company’s cofounders made “material misstatements and omissions that were intended or designed to deceive the investors” — which violates Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 (“Securities Act”), and Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5.
The Celebrity Promoters:
This ICO used celebrity promoters DJ Khaled and Floyd Mayweather, although the promoters are not named or mentioned in the SEC’s Complaint — so at this time, have no liability. As I mentioned in a previous blog, ( https://www.sashahodler.com/single-post/2018/02/23/THE-LEGALITIES-OF-CELEBRITY-BACKED-ICOs ) the SEC can go after promoters under their Securities Laws, however it looks like they are not doing so yet. “As we allege, the defendants relied heavily on celebrity endorsements and social media to market their scheme,” said Steve Peikin, Co-Director of the SEC’s Division of Enforcement.
“Endorsements and glossy marketing materials are no substitute for the SEC’s registration and disclosure requirements as well as diligence by investors.”
The SEC is seeking the following:
1. Injunction from engaging in this course of business (stop the sham);
2. Disgorge their ill-gotten gains and to pay prejudgment interest thereon (give back the $32 million to the ICO purchasers);
3. Civil money penalties — these come in three tiers –
a. Tier 1 — $5,000 for each violation by an individual, or $50,000 by a company; or the gross amount of the gain, b. Tier 2 — when there is fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement — $50,000 to an individual or $250,000 to a company, and c. Tier 3 — when the fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons — $100,000 to an individual and $500,000 to a company. (I think this is where Centra will fall)
4. Prohibiting Defendants from acting as an officer or director of any public company; and
5. Prohibiting Defendants from participating in any offering of digital or other securities.
The Egregious Highlights:
The Fake Product:
Centra purported to be creating a “crypto debit card” that was connected to a virtual “smart wallet” via an Apple or Android application in partnership with Visa, Mastercard and Bankcorp. Apparently they had no connection to any of these companies. On August 30, 2017, Bancorp had to issue Centra a notice, directing them to “CEASE AND DESIST FROM REPRESENTING THAT THE BANCORP BANK HAS ANY CONNECTION WITH, OR IS THE ISSUER OF ANY CARD PRODUCTS RELATED TO CENTRA TECH . . . [and from] USING OUR LOGO OR OTHER IMAGES IN CONNECTION WITH THE MARKETING OF ANY PRODUCT OR WALLETS YOU OFFER.” Even after getting this letter, they left the Bankcorp partnership misinformation up on their website. The SEC says this was reckless.
The Fake Insurance Policy:
In Paragraph 69 of the Complaint, the SEC alleges that, “Defendants also made up a fictitious relationship with an insurance company. Centra claimed in its White Paper that, “[a]ll digital currency that Centra Tech holds online is fully insured . . . The policy is provided by a syndicate of insurers through the Protarian Insurance [sic] Group.” In reality, it turns out that is a fictitious company, and nobody offers insurance for ERC 20 Tokens.
The 38 Fake Money Transmission Licenses & Fake Exchange Listing Contracts:
They also listed in their White Paper that they had Money Transmission licenses in 38 states, when in actuality; they did not have a single one. Additionally, they falsely purported they were being listed on get listed in on Kraken, with contracts in place for Poloniex and Bitrex to follow, all lies, and none of these exchanges listed the token. The SEC said this was material to investors.
The Fake Advisory Board, Dividends & Pitch Deck Promises:
The fictional Advisor Biographies and Linked in Profiles of the CEO and CFO were also material misstatements. In their marketing material, they claimed their CEO and Co-Foounder, Michael Edwards had invested significant capital into the project. Apparently they made up Mr. Edward’s entire identity, and the photo they used was a Canadian physiology professor with no link to the company. Centra also falsely promised dividends with their ICO, called it the “Centra Token Rewards Program” which supposedly entitled investors to share in .8% of Centra’s future earnings. Their pitch deck was also referenced as a material misrepresentation, where they declared expected revenue of $12 million by 2021. This number is surprisingly low considering how extra everything else is.
The two actual co-founders were served Subpoenas by the SEC on Feb 9 and Feb 13, 2018. As of March 30, 2018, Centra’s bank accounts were depleted and most of its employees had been terminated. It is thought, “upon information and belief” that the ICO money is held in a crypto wallet.
These co-founders are crazy not to have left America sooner. The same insanely arrogant personality that led them to think they could get away with this blatant fraud must have contributed to their reasoning that were somehow untouchable despite the many SEC warnings that have been issued since the conclusion of their ICO last fall. This kind of behavior is what gives crypto a bad name. I am guessing the assets in the digital wallet — thought to be the ICO funds — will be seized, and if the authorities can successfully obtain private keys, the funds will be returned to the investors.
This was certainly a low hanging fruit for the SEC, it has every element in their favor the clearly bad actors and the easy allegation for unregistered security offerings with the .8% Centra Dividend “reward.” What this means for the overall ICO space, I’m not too sure. Since the celebrity promoters weren’t mentioned in the complaint, I don’t think the community will find this a harsh warning that all promoters and advisors potentially have civil and criminal liability when soliciting the general public. And, since this ICO has so many egregious characteristics, the general ICO space will probably continue business as usual thinking that their offering is not at risk because they are not lying to their purchasers, or their Token has a valid utility which the Centra one clearly did not.
Interestingly, the complaint did not condemn all ICO’s, it specifically listed this one was a security because it offered the reward/dividend. There was no Howey analysis performed. With all the other bad facts in this case, this is a great way for the SEC to get the first precedent of an ICO being a Securities Offering on the books.
I will be very interested to read the Defense’s arguments against that Securities classification, because without it, none of the criminal or civil penalties for the material misrepresentations could stick. With the offering of the dividend, and quoting of exchange partnerships and the outright lies littered throughout the entire project, this one will be difficult for any attorney to defend. I wonder if they will even find an attorney willing to take the case. The SEC will likely get their first black letter law on the books setting the precedent that (some) ICOs are in fact securities. So far it’s just been statements and press releases, but no actual caselaw. This case has such a weak defense due to the surrounding fraud, that the law will be set, and then likely applied against many other ICO projects.
I’m also unclear as to why the jurisdiction was set in the Southern District of New York considering the defendants resided in Florida, and the company was headquartered in Florida, and registered in Delaware. This same thing happened in Ross Ulbright’s trial, where it was pulled into the second circuit when no parties involved had any meaningful connection in New York. New York is the most unfriendly crypto state in the country with the Bitlicense requirements, so it seems to me this case is going to be a slam dunk for the government to get some pervasive rules on the books against ICOs. I guess the intention is to help main street investors avoid scams, and not to stifle bitcoin in any way.
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Disclaimer: This blog is not legal advice.