Blockchain technology is often touted for its enormous potential to revolutionize many aspects of the financial system. This relatively new technology, however, does nothing to eliminate would-be criminals from leveraging age-old fraud schemes. The SEC's recent case against BitConnect bears this out. The proceeding also demonstrates that the federal government maintains a strong interest in rooting out old-fashioned fraud, even in the digital asset space.
BitConnect was an open-source cryptocurrency released in 2016 with the goal of allowing users to lend the value of BitConnect coin in return for interest payments. The BitConnect operation was shut down in January 2018. Three-plus years later, the company and its primary stakeholders find themselves staring down at civil and criminal liability.
On September 1, the SEC charged BitConnect, its founder Satish Kumbhani, and lead promoter Glen Arcaro and his company Future Money in the Southern District of New York with defrauding investors and offering unregistered securities. That same day, Arcaro pled guilty to the criminal charge of conspiracy to commit wire fraud in connection with his role as the top promoter for BitConnect. As part of the plea, Arcaro promised to repay approximately $24 million in ill-gotten gains.
Nothing More Than a Ponzi Scheme
According to the SEC's complaint, BitConnect sought investors for a "Lending Program" with the promise that it would use a proprietary "volatility software trading bot" to generate returns "as high as 40% per month" with "no risk." To further the fraud, BitConnect and Kumbhani posted fictitious returns online. Of note, the SEC maintains that the Lending Program was offering investment contracts, thus qualifying it as a security.
BitConnect also pursued investors through a series of commissioned promoters, including Arcaro, who used YouTube videos touting the Lending Program and the daily returns generated by the trading bot. As an example of his extraordinary hubris, Arcaro represented during an online webinar that BitConnect's trading bot had paid positive interest to investors every day from March 11, 2016 to August 2017.
This promotion appears to have been nothing but a ruse. Promoters were paid secret "development funds" that were hidden from investors—these fees were in addition to disclosed commissions—and instead of generating returns through a proprietary trading platform, BitConnect and Kumbhani siphoned off investor funds for personal use.
For their part, investors deposited funds with BitConnect and were then told they could not cash out their investments. Thereafter, BitConnect created false records to show the generation of returns. When investors became adamant about being paid out, BitConnect did so not with investment returns, but with the deposits of subsequent investors. In fact, BitConnect did not produce an ROI as represented. Not surprisingly, once the scheme was uncovered, the value of BitConnect's proprietary digital asset, BitConnectCoin, cratered in value, and BitConnect ceased trading, leaving investors with worthless assets.
In the end, BitConnect was nothing more than a Ponzi scheme, one that did not rely on human intelligence, engineering access to private keys, or even hackers. Rather, investors—some of whom attended BitConnect-promoted events in California and Thailand—were drawn in by a fleet of grifters using flashy videos promising inflated daily returns that were just too good to be true. In all, the BitConnect scheme is alleged to have duped investors out of more 325,000 BTC, valued at more than $2 billion.
The SEC is seeking a permanent injunction barring BitConnect, Kumbhani, Arcaro and Future Money from participating in or operating any digital asset sale referral program; disgorgement of all ill-gotten gains received from the scheme; and payment of civil penalties.
Kumbhani, whose whereabouts are unknown, has yet to be publicly charged criminally. That being said, given Arcaro's guilty plea, Kumbhani may already be charged under seal, and he could ultimately face counts of conspiracy to commit wire fraud or securities fraud. In addition, he is likely to be charged with wire fraud for, at a minimum, the transfers of BTC from investors to personal wallets. And to the extent Kumbhani was attempting to pass off illegitimately obtained BTC as legitimately earned by BitConnect, he could also confront conspiracy or substantive charges of money laundering.
Notably, this is the second action that the SEC has brought against those involved in the BitConnect scheme. On May 28, 2021, the SEC filed an action against five promoters—none of whom were registered as broker-dealers—accused of marketing BitConnect's unregistered securities. To date, the SEC has obtained judgments, including permanent injunctive relief, disgorgement and penalties, against two of them.
In addition to the SEC, the Department of Justice has shown an interest in prosecuting fraud related to digital assets as well. On September 15, Stefan Qin, the founder of two crypto hedge funds, was sentenced to 90 months in prison after pleading guilty to one count of securities fraud for operating a $90 million Ponzi scheme.
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