Regulatory uncertainty around the fledgling crypto sector is no excuse for fraud in that space, according to a regulatory hearing panel.
Earlier this year, the British Columbia Securities Commission (BCSC) ruled that David Smillie and his company, 1081627 B.C. Ltd. (operating as ezBtc), defrauded investors that used their crypto trading platform when they lied about about holding the investors’ crypto assets in cold storage. Instead, the company diverted investors’ assets to online gambling sites and other crypto platforms, according to the BCSC.
The case highlights the difficulty of setting sanctions for misconduct involving volatile crypto assets.
Now, following a hearing on sanctions, the panel ordered Smillie and the company to jointly pay $10.4 million is disgorgement, and Smillie pay an $8 million penalty. He was also permanently banned from the securities industry in B.C.
According to the panel’s decision, “In this case, the respondents lied repeatedly to customers that crypto assets deposited on the ezBtc platform would be stored by ezBtc in cold storage for increased safety. Instead, they diverted a significant portion of those assets to Smillie’s personal accounts on other crypto exchanges and to gambling websites.”
“Smillie also lied repeatedly to customers about the reasons for delays or non-payment of customer withdrawals. He threatened customers who complained publicly with defamation lawsuits,” it noted.
The panel said that Smillie argued that there was, “no evidence that the purpose of ezBtc was to commit a fraud on customers,” and that the uncertain regulatory landscape for the crypto sector at the time (2016 to 2019) should be considered a “significant mitigating factor” in setting sanctions in the case.
“We disagree,” the panel said. “Whether or not the respondents understood crypto asset trading platforms to be subject to securities law and commission oversight, they could not have had a legitimate expectation that it was permissible to defraud customers and deprive them of their assets.”
While BCSC staff sought a permanent ban against Smillie, the panel said he argued that a 10-year prohibition would be more appropriate.
The panel sided with the regulator however, ruling that, “Smillie failed to act honestly or in the best interests of ezBtc’s customers. His behaviour falls far short of that expected of market participants; he is unfit to participate in the capital markets.”
“His argument that his behaviour is mitigated because there was regulatory uncertainty at the time shows a continuing failure to understand or accept that fraud is not acceptable regardless of how one’s activities are regulated,” it said.
As a result, it permanently banned him from the markets.
As for setting monetary sanctions, the case highlighted a challenge when it comes to valuing crypto assets in an enforcement proceeding.
In this case, the panel found that ezBtc’s customers were deprived of 866.84 bitcoin and 159 ether, and that there should be disgorgement ordered to deprive the perpetrators of the benefits of their misconduct — yet, it noted that the value of these assets “fluctuated significantly” during the misconduct.
Indeed, the value of the crypto that was taken amounted to about $1.6 million in early 2017. It was up to $13 million by mid-2019, and was worth about about $94 million when the BCSC hearing took place earlier this year.
The panel noted that the BCSC sought disgorgement of $13 million, which was the value in mid-2019 that marked, “the approximate midpoint of customer complaints to the commission.” It argued that this represented, “a reasonable approximation of the amount obtained by the respondents as a result of their fraud.”
The panel said that Smillie argued that the disgorgement should be calculated based on the value of the crypto when it was taken, not at a later date, when it had risen in value.
However, the panel concluded that it would be impractical to value each fraudulent transfer when it occurred, and that it would not be in the public interest to adopt a methodology that puts the lowest possible value on the missing assets.
Ultimately, the panel set the valuation date at April 30, 2018 — the midway point in the long-running fraud — and, using data from CoinMarketCap.com, concluded that the value of the crypto at that time was approximately $10.4 million. It ordered disgorgement in that amount against Smillie and the company.
As for a monetary penalty, the BCSC asked for $13 million, while Smillie argued for $250,000, which the panel said, “is woefully inadequate and not supported by precedents.”
Instead, it ruled that an $8 million penalty, “is appropriate, proportionate and meets the need to send a clear message for specific and general deterrence.”
There was no penalty ordered against the company, which is insolvent, has no assets or operations and “did not act independently of Smillie in perpetrating the fraud,” the panel said.