Federal Agencies Coordinate Action Against Celsius for Fraud and Manipulation

In Short

The Situation: In parallel federal actions, the Department of Justice ("DOJ"), Securities and Exchange Commission ("SEC"), Commodity Futures Trading Commission ("CFTC"), and Federal Trade Commission ("FTC") brought actions against Celsius Network LLC ("Celsius") and one of its founders and former chief executive officer, Alexander Mashinsky ("Mashinsky"), and other persons related to Celsius.

The Result: Federal agencies are taking a unified stand against fraud and manipulation in the digital asset ecosystem. Absent statutory regulation of digital assets, companies and retail users should expect that agencies with concurrent jurisdiction will continue to seek large penalties in their pursuit of fraud and manipulation in the digital asset ecosystem.

Looking Ahead: Market participants and spectators should expect continued coordinated multiagency enforcement actions as the DOJ, SEC, and CFTC continue their aggressive pursuit of cases related to digital assets, decentralized finance ("DeFi"), and crypto products generally. Participants should also monitor other federal regulators with concurrent jurisdiction, as the FTC action signals that agency's desire to assert jurisdiction in digital asset matters.

DOJ Action

On July 13, 2023, the U.S. Attorney's Office for the Southern District of New York, along with the New York Field Office of the Federal Bureau of Investigation, announced the unsealing of an indictment charging Mashinsky with securities fraud, commodities fraud, and wire fraud for defrauding customers and for a series of misrepresentations about Celsius's success, profitability, and the nature of the investments Celsius made using customer funds. Further, Mashinsky and Roni Cohen-Pavon, Celsius's former chief revenue officer, were charged with conspiracy, securities fraud, market manipulation, and wire fraud for illegally manipulating the price of "CEL," Celsius's crypto token, while also secretly selling their own CEL at artificially inflated prices. Mashinsky was arrested, but Cohen-Pavon, an Israeli citizen and resident, is currently abroad. 

Celsius, which purportedly held $25 billion in assets at its peak, provided customers with a variety of products and services, including custody of crypto assets, loans secured by crypto assets, and yield for the deposited crypto assets. According to the indictment, Celsius was the self-proclaimed "safest place for your crypto." Mashinsky is alleged to have made repeated public statements misleading users about Celsius's financial condition, particularly about Celsius's yield-generating activities, profitability, and risk. Similarly, Mashinsky and Cohen-Pavon are alleged to have artificially inflated the price of CEL by using customer deposits to make undisclosed market purchases of CEL. Mashinsky and Cohen-Pavon are alleged to have made millions selling their own CEL holdings while at the same time urging customers to hold their own assets within their accounts. Mashinsky also is alleged to have withdrawn approximately $7.8 million worth of non-CEL crypto assets from his Celsius accounts.

The United States and Celsius entered into a non-prosecution agreement for any crimes (except criminal tax crimes) related to the alleged scheme to defraud and manipulation of the price and volume of CEL whereby Celsius, which is currently in Chapter 11 bankruptcy proceedings, has agreed to accept responsibility for its role in the fraudulent schemes.

SEC Action

The SEC's complaint alleges that Celsius and Mashinsky engaged in unlawful offers of unregistered securities, fraud, and market manipulation under the Securities Act of 1933 and the Exchange Act of 1934 in connection with CEL and the company's "Earn Interest Program." Relying on S.E.C. v. W.J. Howey, 328 U.S. 293 (1946), the SEC alleges that the defendants offered and sold both CEL and the Earn Interest Program as investment contracts and thus securities without filing a registration statement.

The complaint further alleges that the defendants continually misrepresented core aspects of Celsius's business to investors, including by making false and misleading statements about trading and business strategies, risks, the company's business model, its financial health and success, and the safety of customer assets on the Celsius platform. A few of the myriad alleged misrepresentations include the defendants stating that Celsius did not make uncollateralized loans, the company had one million active users, and the company raised $50 million from its initial coin offering. The SEC's complaint alleges that Celsius actually made uncollateralized loans totaling millions of dollars, had only approximately 500,000 total users, and raised roughly $18 million less than its publicly stated $50 million initial coin offering. Furthermore, in the months leading up to Celsius' bankruptcy filing, the defendants repeatedly told the public that the company had a strong financial condition and outlook, even falsely claiming that investor assets were insured.

In addition to the alleged false and misleading statements, the SEC claims the defendants manipulated the market for CEL. Beginning in at least 2020, the SEC alleges, the defendants artificially increased and supported the price of CEL through manipulative buybacks of CEL far in excess of their publicly disclosed purchases.

The SEC seeks: (i) injunctive relief; (ii) disgorgement of ill-gotten gains with prejudgment interest; (iii) civil penalties to be determined by the Court; (iv) a permanent ban on Mashinsky acting as an officer or director of any issuer; and (v) a permanent ban on Mashinsky participating in or inducing the purchase, offer, or sale of any crypto asset securities.

CFTC Action

In its first action against a digital asset lending platform, the CFTC alleges that from 2018 through at least June 2022, Celsius and Mashinsky "engaged in a scheme to defraud hundreds of thousands of customers by misrepresenting the safety and profitability of its digital asset-based finance platform."

According to the complaint, Celsius touted the opportunity for returns of 4.5% to 17% in exchange for the deposit of digital assets, including digital asset commodities. Celsius then pooled and deployed those digital asset commodities as loans to institutional and retail customers and for the trading of futures contracts, among other revenue-generating activities. Celsius allegedly claimed to offer yield payments derived from the returns it received on its asset deployment. Celsius also allegedly increased revenue streams using DeFi lending, staking, Bitcoin mining, and custodial services. As alleged in the complaint, Mashinsky claimed that yield rates varied based on weekly demand for each coin and a promise that 80% of Celsius's revenue would be paid to investors, and Celsius claimed that customers would always keep 5% annual interest on lent cryptocurrencies.

The CFTC alleges that, to attract customers and induce additional deposits, Mashinsky routinely misrepresented that Celsius only issued collateralized loans. The complaint claims that, although Celsius was unable to operate at or above net interest margin and generate sufficient yield on its asset deployment to pay its customers what it promised, Celsius kept its reward rates high.

The complaint asserts that during the crypto winter of 2021, Celsius experienced large financial losses and scant opportunities to deploy remaining assets in its possession. Despite the defendants' difficulty generating revenue, Mashinsky often misrepresented the safety and profitability of Celsius through tweets and "Ask Mashinsky Anything" videos that, according to the CFTC, were designed to solicit new customers to garner more deployable assets. The complaint declares that Mashinsky was aware that the business model required new customers to sustain growth and more deposits and, as such, mispresented the number of active customers. Based on the CFTC's statement of the facts, by June 2022, Celsius had 584,192 registered U.S. customers, but 386,294 of them held an account balance of less than one dollar.

The alleged misrepresentations included false statements regarding regulatory compliance; safety of customers' assets, collateralization of loans issued by Celsius, the extent and risk of DeFi activity, the risk profile of institutional partners, the exposure to directional trading, and the amount of leverage involved. The CFTC also accused Mashinsky of lying about whether he was holding or selling CEL and about the financial condition of Celsius leading up to Celsius' June 2022 pause on all customer withdrawals.

The defendants are charged with violating Sections 4k(2), 4m(1), 4o(1)(A)–(B) and 6(c)(1) of the Commodity Exchange Act and CFTC Regulations 4.21(a)(1) and 180.1(a)(1)–(3). The charges include Celsius failing to register as a commodity pool operator ("CPO") and Mashinsky failing to register as an associated person of a CPO. The CFTC seeks: injunctive relief; disgorgement of all benefits received, including prejudgment and postjudgment interest; restitution payments to each customer or investor; and civil monetary penalties.

FTC Action

The FTC also filed a complaint against Celsius, Mashinsky, and co-founders Shlomi Leon and Hanoch Goldstein for violations of the Federal Trade Commission Act ("FTC Act") and the Gramm-Leach-Bliley ("GLB") Act. The FTC's complaint alleges the defendants' misrepresentations violate Section 5(a) of the FTC Act, which prohibits "unfair or deceptive acts or practices in or affecting commerce," and that misappropriation of consumers' crypto deposits violates Section 5 of the GLB, which requires banks provide certain notices to their customers.

The FTC's complaint accused the defendants of falsely advertising that a $750 million insurance policy covered consumers' assets and failing to track Celsius's available assets or consumer liabilities. The complaint documented customer losses totaling approximately $4.7 billion of crypto assets.

On the same day, the FTC announced a settlement with Celsius that will permanently ban it from offering, marketing, or promoting any product or service that could be used to deposit, exchange, invest, or withdraw any assets, including through an intermediary. Additionally, Celsius agreed to a judgment of $4.72 billion, which will be suspended to permit the company to return its remaining assets to consumers in bankruptcy proceedings. Celsius is required to submit a compliance report one year after the entry of the settlement, and Celsius must also create certain records for 20 years and retain each such record for five years. None of the former executives or co-founders have agreed to a settlement, and the FTC case against them is ongoing.

Five Key Takeaways

  1. Crypto market participants should take note that government agencies are coordinating to bring criminal and civil enforcement actions against the crypto industry in appropriate cases. In doing so, they are filing charges under other statutes and regulations beyond the federal securities laws.
  2. The SEC continues its aggressive enforcement of cryptocurrency-related violations, relying on the allegation that crypto assets and yield-earning programs are investment contracts and thus securities.
  3. The CFTC will continue pursuing cases where it believes customers have been defrauded, as well as cases involving alleged manipulation of digital asset markets, including in cases where the SEC has also brought suit for securities law violations. 
  4. In addition to the usual players, the FTC also bringing an action demonstrates that agency's willingness to charge crypto industry actors; crypto businesses should be aware of other potential sources of regulatory enforcement risk.
  5. Digital assets present unique risks, and it can be challenging to understand how current laws apply. Companies seeking to utilize digital assets and digital asset markets should consult with counsel to navigate the regulatory landscape and ensure the maximum level of risk mitigation.
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