Federal judge says SEC rules apply to initial coin offering

Key Points
  • A federal judge in Brooklyn refused to throw out a case in which a defendant argued two cryptocurrencies were beyond the reach of federal securities laws.
  • Bitcoin and ether are the only digital assets the SEC has explicitly said are exempt from Securities law, and are instead viewed as commodities.
  • The judge in this case denied the motion to dismiss, and said current securities laws should be clear enough for a jury to decide. 
A Bitcoin crypto-currency shop in Rovereto, Italy.
Pierre Teyssot | AFP | Getty Images

A cryptocurrency founder's effort to dismiss a federal case against him by arguing that cryptocurrencies he created were not securities for the purpose of criminal law was shot down by a judge in Brooklyn, New York Tuesday.

A key part of defendant Maksim Zaslavkiy's argument was that current laws around crypto are "unconstitutionally vague." U.S. district judge Raymond Dearie disagreed, and said a reasonable jury should be able to apply what's known as the Howey Test.

The judge stopped short of defining RECoin and Diamond, two cryptocurrencies in question, as securities. But Dearie did say the jury should be able to assess them using existing laws.

"Though 'investment contract' has not been defined by Congress, the test for whether a "given financial instrument or transaction constitutes an 'investment contract' under the federal securities laws," has long been settled," Dearie said.

Whether an asset is a security right now follows the "Howey Test." The ruling comes from a 1946 U.S. Supreme Court case that classifies a security as an investment of money in a common enterprise, in which the investor expects profits primarily from others' efforts.

SEC Chairman Jay Clayton made it clear in June that the agency won't bend the rules for cryptocurrency when it comes to defining what is or what isn't a security. As of Tuesday, bitcoin and ether are the only cryptocurrencies the SEC has come out and said are exempt from Securities law. 

Clayton has also said that all other initial coin offerings constitute securities, and "if it's a security, we're regulating it."

"We are not going to do any violence to the traditional definition of a security that has worked for a long time," U.S. Securities and Exchange Commission Chairman Jay Clayton told CNBC earlier this year. "We've been doing this a long time, there's no need to change the definition."

Zaslavkiy joins a growing list of alleged cryptocurrency fraudsters. He was indicted by the U.S. Department of Justice for making false and fraudulent representations for virtual currencies known as "REcoin" and "Diamond." Zaslavskiy allegedly tricked investors into buying digital tokens that he claimed were backed by real estate and diamonds.

The judge called Zaslavskiy's reading of the relevant law "overly narrow," and said such contracts embody "a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits."

Other well-known cryptocurrency founders have challenged the SEC's current view on cryptocurrencies. Blockchain start-up Ripple has repeatedly said its XRP cryptocurrency is not a security. Others argue they should be viewed as "utility tokens" because they often promise access to a network, platform or service instead of just profits. But they're often backed by an abstract idea, or nothing at all.

— CNBC's Dan Mangan contributed to this report.