FTC Spearheads Agency Action Against Bankrupt Crypto Lender Celsius Network

Practical Law Legal Update w-040-2047 (Approx. 9 pages)

FTC Spearheads Agency Action Against Bankrupt Crypto Lender Celsius Network

by Practical Law Finance

FTC Charges

In its first ever action against a digital asset company, the FTC filed a complaint against Celsius co-founders and executives Mashinsky, Shlomi Daniel Leon, and Hanoch "Nuke" Goldstein, charging them with violations of:

Section 5(a) of the FTC Act (15 U.S.C. § 45(a)), which prohibits unfair acts or practices in or affecting commerce.
Sections 521 and 521(a)(2) of GLBA (15 U.S.C. §§ 6821 and 6821(a)), which prohibits any person from obtaining or attempting to obtain the customer information of a financial institution from a customer of a financial institution by making false, fictitious, or fraudulent statements or representations to a customer of a financial institution.

The FTC complaint alleges that these charges were brought because Celsius and its founders:

"Duped" customers into transferring their cryptocurrency assets onto the Celsius platform.
Promised consumers that Celsius was “safer” than a bank or other traditional financial institution and misrepresented that their deposits were safe because Celsius earned profits at “no risk” to consumers by making secured crypto loans to other exchanges.
Falsely advertised that a $750 million insurance policy covered consumers’ assets and falsely informed customers that they could withdraw their funds at any time.
Enticed consumers to deposit their cryptocurrency into the Celsius Earn Interest Program (EIP) by claiming that consumers could earn "up to 17%" or "up to 18.63% APY" on EIP deposits.
Used the above misrepresentations to entice customers to provide Celsius with their financial information.
Misappropriated customer funds.

According to an FTC press release, Celsius and the FTC reached an agreement and submitted a proposed stipulation to the US District Court of the Southern District of New York (SDNY). However, the FTC has not reached an agreement with the Celsius founders and has indicated it plans to proceed against them in federal court. According to the stipulation, Celsius is prohibited from offering, marketing, or promoting any product or service that could be used to deposit, exchange, invest, or withdraw any assets.

Additionally, Celsius agreed to a judgment of $4.7 billion, the second-largest settlement in FTC history, which will be suspended to permit Celsius to return its remaining assets to consumers in its bankruptcy proceedings (for information on Celsius bankruptcy, see Practice Note, Bankruptcy: Cryptocurrency Case Tracker: Celsius Network LLC).

SEC Charges

The SEC filed a complaint against Celsius and Mashinsky charging them with violating the registration and anti-fraud provisions of the Securities Act and the anti-fraud provisions of the Exchange Act. According to the SEC's complaint, Celsius and Mashinsky violated the Securities Act and Exchange Act when they:

Conducted unregistered offers and sales of crypto-asset securities to Celsius customers through the EIP in violation of Sections 5(a) and 5(c) of the Securities Act (15 U.S.C. §§ 77e(a) and 77e(c)).
Defrauded Celsius investors by violating:
- Sections 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act (15 U.S.C. §§ 77q(a)(1) to 77q(a)(3)), which prohibit the offer, purchase, or sale of securities to defraud;
- Section 10(b) of the Exchange Act (15 U.S.C. § 78j(b)), which prohibits, among other things, the making of untrue statements of material fact in the offer, purchase, or sale of securities; and
- Section 9(a)(2) of the Exchange Act (15 U.S.C. § 78i(a)(2)), which prohibits creating actual or apparent active trading in a security or raising or depressing the price of a security for the purpose of inducing the purchase or sale of such security by others.

According to an SEC press release, Celsius is cooperating with the SEC and has consented to the relief requested in the complaint, which includes a permanent injunction against future securities law violations.

CFTC Charges

The CFTC filed a complaint against Celsius and Mashinsky, charging them with violations of:

Section 4k(2) of the CEA (7 U.S.C. § 6k(2)), which prohibits acting as an unregistered commodity pool operator (CPO).
Section 4m(1) of the CEA (7 U.S.C. § 6m(1)), which prohibits unregistered CPOs to engage in means of interstate commerce as a CPO.
Section 4o(1)(A)-(B) of the CEA (7 U.S.C. § 6o(1)(A)-(B)), which prohibits:
- an individual to act as an associated person (AP) of a CPO without registration as an AP of a CPO; and
- the engagement in transactions, practices, or courses of business which operated as a fraud or deceit upon pool participants or prospective pool participants.
CFTC Regulation 4.21(a)(1) (17 C.F.R. § 4.21(a)(1)), which prohibits the failure to provide prospective pool participants with pool disclosure documents.

According to a CFTC press release, the CFTC and Celsius agreed to resolve the charges against Celsius by imposing a permanent injunction prohibiting future violations of the CEA. The CFTC is continuing to pursue its litigation against Mashinsky.

CFTC Commissioner Kristin N. Johnson issued a related statement that listed the following lessons for firms operating in the financial services community, including cryptocurrency or digital asset services firms:

Firms become subject to regulation when they engage in financial services activities or certain types of financial transactions.
Financial markets demonstrate endemic fragilities and are tremendously interconnected.
There are many (sometimes hidden) correlations among diverse assets, asset classes, and actors across the financial markets ecosystem.
The events that led to the Celsius bankruptcy (and the bankruptcies of several other crypto firms last year) were quite simply the same "runs" or "dashes for cash" that the CFTC sees in highly regulated segments of the financial services sector.

DOJ Charges

The SDNY unsealed an indictment brought by DOJ against Mashinsky and Celsius chief revenue officer Roni Cohen-Pavon, charging them with securities, commodities, and wire fraud. The indictment alleges that Mashinsky and Cohen-Pavon:

Induced investors and customers to invest their money with Celsius, specifically the EIP.
Dissuaded investors and customers from withdrawing funds they invested with Celsius.
Provided assurances that investment and custody of investors and customers funds at Celsius were safe and low risk.
Frequently made false and misleading public statements about the core aspects of Celsius's financial condition and business operations in order to suggest that Celsius was a safe and low-risk investment opportunity for retail crypto customers, including misrepresentations related to the amount of money Celsius raised through its initial coin offering (ICO), as well as:
- its profitability, the sustainability of its reward rates, and the percentage of its revenue it returned to customers;
- its purportedly "market-neutral" trading strategy;
- its uncollateralized loans;
- its institutional counterparty defaults;
- the degree to which Celsius had clarity or comfort from regulators regarding the viability of its business model;
- the safety of Celsius customer assets; and
- its solvency and liquidity in the days and weeks leading up to the June 12, 2022 "pause" on customer withdrawals that portended the Celsius bankruptcy filing shortly thereafter.

According to a DOJ press release, Celsius has agreed to settle these charges and the DOJ issued a letter memorializing the non-prosecution agreement it reached with Celsius. DOJ continues to pursue charges against Mashinsky and Cohen-Pavon.

Update: On September 11, 2023, the DOJ issued a letter accepting the guilty plea of Cohen-Pavon to the four counts of the indictment in which he was named, specifically:

Conspiring to manipulate the price of a security.
Participating in a fraudulent scheme to manipulate the price of a security and aiding and abetting in same.
Manipulating of the price or volume of a security and aiding and abetting in same.
Committing wire fraud in connection with a scheme to defraud investors and aiding and abetting in same.

According to the letter, Cohen-Pavon will make restitution in an amount to be specified by the court.

NYAG Charges

On August 4, 2023, a judge in the New York County Supreme Court denied Mashinsky's motion to dismiss the New York Attorney General's complaint against him for, among other things, violation of state anti-fraud and investor-protection laws, finding that:

The NYAG sufficiently alleged that:
- the Celsius Earned Interest Accounts (EIAs) are securities under the Martin Act (N.Y. Gen. Bus. Law § 352-c);
- the Celsius CEL tokens are commodities;
- Mashinsky operated as a salesperson of securities and commodities; and
- the EIAs satisfy the Howey test developed by the US Supreme Court in SEC v. W.J. Howey Co. (328 U.S. 293 (1946)) (see Howey Test Flowchart).
There are sufficient allegations to support a plausible inference that Mashinsky's alleged misstatements induced or promoted new investors to deposit assets into EIAs, and the Martin Act does not require investors to take any specific action so long as a defendant has engaged in fraudulent conduct when engaged to induce or promote the issuance, distribution, exchange, sale, negotiation, or purchase of any securities or commodities.
The NYAG complaint sufficiently pleads material misrepresentations, omissions, fraud, and damages with particularity.

The New York County Supreme Court judge ordered Mashinsky to file an answer to the NYAG complaint within 30 days of the court's order and appear at a preliminary conference. (The People of the State of New York by Letitia James, Att'y Gen. of the State of New York, Plaintiff, v. Alex Mashinsky, Defendant, No. 450040/2023, (N.Y. Sup. Ct. Aug. 4, 2023)).

FTC Spearheads Agency Action Against Bankrupt Crypto Lender Celsius Network | Practical Law