Bitcoin Under SEC Scrutiny: First Civil Prosecution Brought Against Alleged Virtual Currency Ponzi Scheme Company
On July 23, 2013, the SEC ventured into the electronic currency world by filing a civil complaint against virtual currency “trader” Trendon Shavers and his company, Bitcoin Savings and Trust, in the U.S. District Court for the Eastern District of Texas. In its complaint, the SEC alleged that Shavers carried out a Ponzi scheme by targeting the growing allure of a new and cutting-edge monetary technology - Bitcoin. Coming on the heels of highly publicized enforcement actions against Japanese‑based Mt. Gox, this case constitutes the first SEC civil prosecution arising from online virtual currency trading and has future implications for Bitcoin-based businesses.
The SEC’s Case Against Shavers and Bitcoin Bank and Trust
Similar to the strategy of the federal prosecutors who filed a civil forfeiture action against Mt. Gox, the SEC applied for an order freezing the assets of Shavers and Bitcoin Savings and Trust. In doing so, the SEC alleged the classic elements of a Ponzi scheme perpetrated through cutting-edge technology. Shaver allegedly offered and sold interests in his company by falsely promising investors that Bitcoin Savings and Trust’s purported market arbitrage activity would yield up to seven-percent interest weekly with very little risk.
According to the SEC, however, Bitcoin Savings and Trust did not generate returns for its investors through Bitcoin-market arbitrage. Instead, Shavers allegedly carried out a Ponzi scheme whereby he used new investor bitcoins to pay returns he promised on outstanding investments. He also allegedly diverted roughly $147,000 worth of investors’ bitcoins to his own account to fund his day trading and personal expenses, and made preferential redemptions to friends and longtime Bitcoin Savings and Trust investors.
The SEC contends that Shavers’ actions violated the registration provisions (Section 5 of the Securities Act of 1933) and anti-fraud provisions of the federal securities laws. In addition to asking the court to freeze Shavers’ assets, the SEC is seeking various penalties for the alleged violations, including a permanent injunction, disgorgement of ill-gotten gains and civil penalties.
In connection with the filing of the complaint, the SEC Office of Investor Education and Advocacy also issued a warning to investors regarding the dangers of potential investment scams involving virtual currencies promoted over the Internet. The SEC cautioned that “as with many frauds, Ponzi scheme organizers often use the latest innovation, technology, product or growth industry to entice investors and give their scheme the promise of high returns.”
Implications for Bitcoin-Based Businesses
While this enforcement case may seem cutting edge and signal possible future SEC regulatory inquiries for virtual currencies, the application of the federal securities laws here is not surprising. Simply put, this is a case involving a classic Ponzi scheme. Although the SEC leveled Section 5 charges (unregistered security), the unregistered security was not bitcoin itself but rather the investment scheme. The SEC applied the standard “investment contract” and “note” analysis to conclude that the Bitcoin Savings and Trust investment scheme constituted a security under the federal securities laws. The SEC stated:
“Moreover, BTC [Bitcoin] is money. BTC may be used to purchase goods or services, or exchanged for conventional currencies, including the U.S. dollar, Euro, Yen and Yuan. Recognizing as much, the Department of the Treasury issued guidance concerning the applicability of the regulations implementing the Bank Secrecy Act to virtual currencies such as BTC. See Treasury Guidance (FIN-2013-G001) - Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (Mar. 18, 2013).”
Although the decentralized nature of Bitcoin initially seemed to be one of its greatest sources of allure, it now also constitutes one of its greatest risks. This case makes clear that, although Bitcoin is not necessarily described in established securities statutes, the SEC and its regulatory counterparts have every intention of closely scrutinizing transactions involving virtual currencies to adequately monitor and protect the investing public.