On September 1, 2021, the US Securities and Exchange Commission filed suit against several individuals and entities associated with the now-shuttered cryptocurrency exchange platform BitConnect, including its founder, Satish Kumbhani, and its chief promoter in the United States, Glen Arcaro. The lawsuit alleges that Kumbhani and his associates defrauded thousands of investors of nearly $2 billion in cryptocurrency in what the SEC calls a "Ponzi-like" scheme. This filing, coupled with a criminal case against Arcaro brought by the Department of Justice and an earlier SEC civil enforcement action against a group of lower-level promoters, should put cryptocurrency players on notice that the SEC and DOJ are growing increasingly comfortable working in tandem to use traditional enforcement tools in the cryptocurrency arena.
The complaint alleges Kumbhani deceived investors by lying about BitConnect's ability to generate profits through the platform's "Lending Program." The Lending Program required investors to remit Bitcoin to BitConnect in order to purchase "BitConnectCoin," which would in turn be lent back to the platform to trade on Bitcoin's volatility using a purportedly proprietary "Trading Bot." During the relevant period, BitConnect and its network of promoters advertised average daily returns of 1%, with no negative returns for any day, amounting to an annualized return of 3700%. According to the SEC, the Trading Bot was a sham, and the vast majority of investments in the Lending Program were never invested in Bitcoin but were transferred to digital wallet addresses controlled by Kumbhani and BitConnect. The SEC alleges that, instead of running a legitimate trading platform, BitConnect used funds deposited by newer investors to satisfy the withdrawal demands of earlier investors. When several state securities boards caught wind of the scheme, BitConnect immediately closed the Lending Program and BitConnectCoin's value plummeted 92%, causing thousands of retail investors to lose the vast majority of their investment.
The most recent filing marks a significant expansion of an ongoing series of BitConnect criminal and civil enforcement actions and sends a signal to actors in the cryptocurrency space of the potential for joint DOJ-SEC enforcement proceedings. Arcaro pled guilty to a related criminal wire fraud conspiracy charge in the Southern District of California on September 1, and another New York-based SEC lawsuit filed in May against five other BitConnect promoters has already produced agreements by some defendants to pay more than $3.5 million and 190 Bitcoin in civil penalties. Both SEC complaints allege Arcaro and the other BitConnect promoters profited handsomely from their efforts to encourage investment in the Lending Program, through both "referral commissions" (a disclosed percentage of the total investment brought in by each promoter) and unreported "development funds," the existence of which was actively concealed from investors. For Arcaro alone, both the civil and criminal actions allege these sums amounted to almost $25 million dollars.
Aside from the underlying fraud theory, the enforcement actions focus on BitConnect and its promoters' violations of the securities laws' registration and reporting requirements. The September 1 complaint alleges the defendants sold securities in the Lending Program without a registration statement as required by Sections 5(a) and (c) of the Securities Act. Furthermore, both the September 1 and the May 28 lawsuits allege BitConnect's promoters failed to register with the SEC as broker-dealers, in violation of Section 15(a) of the Exchange Act.
This constellation of DOJ and SEC enforcement actions serves as a potent reminder of their joint regulatory authority over cryptocurrency investments and players in the cryptocurrency space—brokers, issuers, and investors alike. The BitConnect saga shows that parties planning on issuing, promoting, or selling cryptocurrency-based securities should take proactive measures to ward against the prospect of facing DOJ and SEC enforcement actions in the future, including:
- Adopting sufficient compliance measures and/or examination of existing compliance practices;
- Implementing internal procedures to report wrongdoing internally; and,
- Creating a vetting process for external broker-dealers.
Co-authored by Peter Vogel
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