Bitcoin Update: Recent Decision May Provide Roadmap for Calculating Damages Associated with Bitcoin Related Litigation

Oct 08, 2014   

October 8th, 2014

On September 18, 2014, the United States District Court for the Eastern District of Texas issued its order granting summary judgment in favor of the United States Securities and Exchange Commission (“SEC”) in the case of SEC v. Shavers, Case No. 4:13-00416 (E.D. Tx. September 18, 2014). While at first glance, the decision may appear to be nothing more than another uncontested motion for summary judgment, the decision is important for the bitcoin industry for several reasons. First, the District Court found that investments in bitcoin can constitute “investment contracts” and thus, “securities” under 15 U.S.C. § 77b the Securities Act of 1933. Second, the Court’s analysis in calculating a reasonable approximation of profits in U.S. dollars from the bitcoin based scheme can provide a roadmap for calculating bitcoin related damages in future litigation.

In its Complaint, the SEC alleged that Shavers violated sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 and section 10(b) and Rule 10b-5 of the Exchange Act, codified at 15 U.S.C. § 77(c) related to his running of a bitcoin investment scheme. As described by the District Court in its Order, the SEC alleged that Shavers founded and operated Bitcoin Savings and Trust (“BST”). From at least February 2011 through August 2012, Shavers sold investments in BST falsely promising investors up to 1% interest daily or 7% interest weekly, purportedly based on Shavers’ trading of bitcoin against the U.S. dollar. What made Shavers’ scheme unique is that he solicited and accepted all investments, and paid all purported returns in Bitcoin. Ultimately, Shavers received at least 732,050 bitcoin in investments of which 180,819 bitcoins constituted ill-gotten gains.

In response to the SEC’s Complaint, Shavers filed a Motion to Dismiss arguing that the District Court lacked subject matter jurisdiction because the investments in BST did not constitute securities under the Securities Act of 1933. More specifically, Shavers argued that 1) bitcoin is not money and is not part of anything regulated by the United States; and 2) that because all transactions were solely in bitcoin, no money ever exchanged hands, thus the investments could not constitute investment contracts and there were not “securities” under the act. [15 U.S.C. § 77b defines “security” as “any note, stock, treasury stock, security future, security-based swap, bond . . . [or] investment contract . . . .” In turn, for purposes of the Securities Act of 1933, an “investment contract” is any contract, transaction, or scheme whereby: 1) a person invests money; 2) in a common enterprise; and 3) is led to expect profits solely from the efforts of the promoter or a third party. See SEC v. W.J. Howey & Co., 328 U.S. 293, 298-299 (1946).]

In denying Shavers Motion to Dismiss and rejecting his arguments, the District Court noted:

It is clear that Bitcoin can be used as money. It can be used to purchase goods or services, and as Shavers stated, used to pay for individual living expenses. The only limitation of Bitcoin is that it is limited to those places that accept it as currency. However, it can also be exchanged for conventional currencies, such as the U.S. dollar, Euro, Yen, and Yuan. Therefore, Bitcoin is a currency or form of money, and investors wishing to invest in [BST] provided an investment of money.

Thus, because bitcoin was used as money, the investments in BST constituted an investment of money and as such, an investment contract under the Securities Act of 1933. Therefore, the District Court found that the investments sold by Shaver constituted “securities” under the Securities Act of 1933. A copy of the District Court’s Order denying Shaver’s Motion to Dismiss can read here.

The Shavers case concluded in the District Court granting the SEC’s unopposed Motion for Summary Judgment. In so deciding, the District Court explained that it enjoyed broad equitable power to order securities law violators to disgorge their ill-gotten gains. However, as Shavers’ scheme solely involved bitcoin, the District Court was tasked with the issue of how to properly determine what constitutes a “reasonable approximation of profits casually connected with the violation.” As noted by the District Court, this task became more difficult in light of the large fluctuations in the exchange rate of bitcoin from the time the Ponzi scheme first started to the ultimate determination of liability. Ultimately, the District Court concluded that a reasonable calculation of disgorgement in U.S. Dollars could be obtained by multiplying the total amount of ill-gotten gains in bitcoin by the average daily price of bitcoin between the time the Ponzi scheme ended and the date of the Court’s ruling. In so calculating, the District Court order Shavers to disgorge $38,638,569. It waits to be seen whether other courts adopt the District Court for the Eastern District of Texas’s logic in calculating bitcoin to U.S. dollar exchanges for judgment purposes in light of bitcoin’s historic volatility. A copy of the District Court’s Order granting summary judgment can be read here.

The Shavers’ decision comes at a time when both federal and state regulators have increasingly turned their attention towards virtual currency. As we have previously reported, New York State has recently proposed a highly detailed regulatory framework for virtual currency businesses. In addition, on August 11, 2014, the Consumer Finance Protection Bureau (“CFPB”) issued a consumer advisory warning customers of the potential risks associated with virtual currencies, including their high volatility and potential use in Ponzi schemes In the same announcement, CFPB announced that it has begun accepting consumer complaints regarding bitcoin transactions and dealings. A copy of our report on CFPB’s announcement can be read here.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of anti-money laundering compliance, administrative law, constitutional law, white collar criminal defense and litigation against the U.S. Department of Justice. If you or your company has a question related to its anti-money laundering compliance obligations, our anti-money laundering attorneys can provide further information. You can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690