U.S. SEC pursuing influencers in USD300 million crypto ponzi scheme

The complaint asserts claims not only against the founders and developers of the Forsage platform, but also against U.S.-based YouTubers and crypto influencers involved in the scheme.  Given the SEC’s recent staffing increases in its crypto assets and cyber unit, this likely will not be the last case of its kind. Influencers and crypto news platforms who are perceived by regulators to be promoting and/or participating in fraudulent crypto schemes could face enforcement investigations, and possible enforcement action and civil liability.

SEC Complaint 

According to the complaint filed 1 August¹, Forsage is a Russia-based crypto investment platform that allegedly operates as a Ponzi scheme.  The complaint names as defendants four Russian nationals who founded and managed the platform, and earned over USD4.8 million in profits.  The SEC alleges that the founders misrepresented the machinations of the Forsage platform, promised unrealistic returns and passive income, and falsely claimed that the platform was not a Ponzi scheme, even after inquiries from multiple regulators.

The complaint also names as defendants seven individuals in the U.S. who promoted and participated in the scheme by investing and recruiting additional investors through various social media platforms, including YouTube, Facebook, Instagram, and Telegram.  These influencer defendants amplified the platform’s promises of passive income and financial independence, and refuted accusations from regulators and the public that the platform was a Ponzi scheme.  In total, the influencer defendants earned at least USD2.3 million in profits on the platform.

All 11 defendants are charged with (a) unregistered offers and sales of securities in violation of Section 5 of the Securities Act of 1933 (Securities Act); and (b) violations of the antifraud provisions of both the Securities Exchange Act of 1934 (Exchange Act) and the Securities Act.

Unregistered offers and sales of securities

The complaint alleges that the influencer defendants made unregistered offers and sales of securities in violation of Section 5 of the Securities Act when they promoted the Forsage platform and encouraged potential investors to purchase ‘slots’ in the platform.  For the influencer defendants, the case will turn on whether the SEC can prove that:

• what they sold or offered to sell—‘slots’ in the Forsage smart contract are even securities at all; and

• that the influencer defendants actually sold or offered to sell the slots.

To prove the slots in the Forsage smart contract are securities, the SEC has to satisfy the Howey test, which requires the SEC to show that the smart contract slots are: (1) an investment of money; (2) in a common enterprise; and (3) with the expectation of profits derived from the efforts of others.

The SEC will argue that the influencer defendants sold the slots in exchange for digital assets that are equivalent to money, that the slots were part of a common enterprise managed by Forsage or the Forsage smart contracts, and that the investors expected profits from the efforts of Forsage management.  The influencer defendants may argue that no profits were expected based on the efforts of others, but rather all profits were dependent on the recruitment efforts of the participants.  This argument may be difficult to defend though, as courts have long held that Ponzi schemes qualify as securities,²  and the defendants’ promises of “passive” income suggests the profits would come from the efforts of others.

According to the complaint, users purchased the slots from the Forsage smart contract, so the influencer defendants did not directly sell the slots.  However, a defendant may be liable for indirect sales where the sale would not have occurred if not for the efforts of the defendant.³ Thus, the SEC will argue that the influencers at least indirectly sold the securities by promoting the platform and encouraging investments from new investors who otherwise would not have invested.

Securities fraud

Under the anti-fraud provisions of the Exchange Act, the SEC must show that each defendant: (1) made a material misrepresentation or a material omission as to which he had a duty to speak, or used a fraudulent device; (2) with at least willful or reckless disregard for the truth or with knowing misconduct; (3) in connection with the purchase or sale of securities.

The elements under the anti-fraud provisions of the Securities Act are essentially the same, though under the Securities Act the SEC can also state a claim if it can prove that the defendants negligently engaged in a transaction, practice or course of business which would operate as a fraud or deceit upon a purchaser of securities.

Assuming the SEC can prove that the slots in the Forsage smart contract are securities, the fraud claims likely will turn on the influencer defendants’ state of mind, because Ponzi schemes have long been recognized as fraudulent schemes or devices.  The SEC must show that the influencer defendants acted knowingly, recklessly, or negligently in promoting the fraudulent scheme.

The SEC will argue that the influencer defendants were well aware of the nature of Forsage.  The complaint alleges they often interacted directly with the founders and had experience in multi-level marketing platforms such that they should have known or at least been aware of the risk that the platform was a fraudulent scheme.  The SEC will argue that the influencer defendants were made aware of the risk that the platform was a fraudulent scheme when they learned of regulatory investigations in Montana and the Philippines.  Failing to investigate whether the platform was a fraudulent scheme in light of this information would tend to suggest a reckless, or at least negligent state of mind.

What next?

Any savvy participant in the digital asset space is likely aware of a number of reportedly questionable investment platforms in the space, ranging from Ponzi-like schemes, to outright theft or “rug-pulls”. So those in the crypto media industry, including influencers, celebrity spokespersons, promoters and news platforms as well as investment advisors, must be aware of the risks of promoting unregistered securities or schemes that the SEC determines to be fraudulent.

The SEC is not likely to pursue every case in which a celebrity, influencer, or other promoter refers potential investors to a digital asset or investment platform that turns out to be a fraud.  However, those who hold themselves out as particularly knowledgeable about a particular project that defrauds investors may face enforcement action. And the SEC has recently committed to increasing the size of its crypto assets and cyber unit, growing from 30 to 50 employees who are committed to investigating digital asset fraud. So the Forsage case is not likely to be the last of its kind.

Moreover, the Securities Act and the Exchange Act provide private plaintiffs a right of action when they are defrauded.  The plaintiffs’ bar is not likely to exercise as much discretion as the SEC in pursuing borderline cases, particularly where promoters hold themselves out as having made considerable profits through their investments.

Plaintiffs in Florida filed suit against Mark Cuban and the Dallas Mavericks on 10 August in relation to the Voyager Digital collapse, alleging that Cuban encouraged plaintiffs to invest in the Voyager platform despite knowing it operated like a Ponzi scheme and misrepresented the risk of investing in the platform.⁴   Earlier in 2022, plaintiffs in California filed a class action against individuals involved in an alleged pump-and-dump scheme known as Ethereum Max among the defendants named in the lawsuit were celebrity endorsers Kim Kardashian, NBA star Paul Pierce, and boxer Floyd Mayweather.⁵ In another recent action, multiple plaintiffs filed lawsuits against social media influencer Jake Paul, former-Backstreet Boy Nick Carter, and others in relation to another alleged pump-and-dump involving the digital asset Moonbeam.⁶  

Tips for influencers

The complaint makes out the Forsage case to be a particularly egregious scheme with knowing participation by the U.S. influencers, so it is not yet clear how aggressive the SEC’s position on influencers and promotors will be going forward.  Influencers should obviously avoid intentionally promoting frauds and deceiving their followers, but they should also:

• Watch out for red flags: influencers should be careful to avoid creating the appearance that they are promoting a scheme they know to be a fraud or that exhibits red flags.  Potential red flags may include, but are not limited to, promises of guaranteed incomes or excessive returns, anonymous or un-doxxed founders or management, unaudited smart contracts, and a failure to identify the source of any income.

• Disclose conflicts of interest: if news alerts and recommendations appear to a regulator to be disguised front-running and pump-and-dump schemes, content creators could be exposed to serious liability.  When discussing an asset or platform that the content creator is invested in, it is advisable to disclose such investments to avoid a conflict of interest and potential legal risk.  Content creators should likewise disclose any affiliation with the assets and platforms they discuss, including when they are being paid for the promotion, and how much they are being paid. 

Regulators have demonstrated that they are taking the digital asset space seriously, and will continue to be active on the enforcement front, even against those who play a less-direct role in conduct that regulators view as problematic.  In this enforcement environment, the ubiquitous influencer disclaimer to “do your own research” or DYOR may not be enough to deter regulators or plaintiffs from pursuing actions where they believe they see evidence of intentional fraud.

Footnotes

_{1. SEC v. Okhotnikov, 1:22-cv-3978 (August 1, 2022, N.D. Ill.)}

_{2. See SEC v. CKB168 Holdings, Ltd., 210 F. Supp. 3d 421, 450 (E.D.N.Y. 2016)} 

_{3. SEC v. E. Delta Res. Corp., No. 10–cv–310 (SJF), 2012 WL 3903478, at *4 (E.D.N.Y. Aug. 31, 2012); see also SEC v. Verdiramo, 890 F.Supp.2d 257, 271–72 (S.D.N.Y. 2011) (finding that defendant “violated Section 5 because he was a necessary and substantial participant in the unregistered sales” made by others)}

_{4. Robertson v. Cuban, 1:22-cv-22538 (S.D. Fla)} 

_{5. In re Ethereummax Investor Litigation, 2:22-cv-163 (C.D. Cal.)}

_{6. Merewhuader v. Safemoon LLC, 2:22-cv-1108 (C.D. Cal)}