SEC Charges Individual for Crypto Token Manipulation Scheme

Commentary by Nihal Patel

The SEC charged an individual with engaging in a scheme to inflate prices in securities on a decentralized exchange, and using swaps contracts, at their inflated value, as collateral to secure other digital assets. The case follows on CFTC- and DOJ-related civil and criminal charges. (See here.)

In the Complaint, filed in the Southern District of New York, the SEC alleged that the individual purchased a significant volume of purported "perpetual futures" contracts connected to the native (governance) token of an exchange. The SEC alleged that the individual then purchased and sold the token between two accounts, resulting in an approximately 2,200 percent increase in the token's value, and a 1,300 percent increase in the value of the futures contracts. The SEC alleged that the individual then used the contracts as collateral to borrow other digital assets, many of which belonged to other investors on the exchange, and withdrew the assets, effectively draining the exchange of all its available digital assets. The SEC said that the individual then stopped manipulating the price of the token, and it dropped by approximately 90 percent in value. The SEC asserted that the underlying tokens were purchased and sold as investment contracts, and therefore considered securities.

The SEC charged the individual with violating Exchange Act Section 9(a)(2) ("Prohibition against manipulation of security prices"), Exchange Act Section 10(b) ("Regulation of the use of manipulative and deceptive devices") and Exchange Act Rule 10b-5(a) and (c) ("Employment of manipulative and deceptive devices").

The SEC is seeking relief in the form of (i) an Order finding that a violation of federal securities laws occurred, (ii) monetary relief including civil penalties, disgorgement of gains, restitution and reimbursement of other administrative costs, (iii) a prohibition on the individual from engaging in any securities-related activity and (iv) any additional relief the court deems appropriate.

Commentary

There is fairly little discussion in the SEC Complaint as to why the MNGO governance token is a "security." This is not to say that the SEC's analysis is wrong, but it's not obvious on its face. Further, there is no discussion of how the SEC's analysis can be correct at the same time that two other arms of the federal government are alleging that swaps on MNGO are "swaps" under the Commodity Exchange Act. If MNGO is a "security," a swap on MNGO should be a "security-based swap" subject to SEC, not CFTC, jurisdiction. The instrument is possibly a "mixed swap" subject to joint jurisdiction (i.e., if, in addition to MNGO, the swap also referenced a non-security), but there's nothing to indicate that the government is suggesting that theory.

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