MSTR Cat

Crypto Law/Level VII · Loopholes worth understanding/7.3 Loopholes they sell you/Lesson 7

Spotting a pitch that ends in court

The features that recur in crypto pitches later described in fraud complaints, the US rules that turn promoters into defendants, and a short routine for checking an offer before money moves.

Education, not legal, tax or investment advice. Crypto law differs between countries and states and changes often. Check the current rules where you live with a qualified lawyer or tax adviser before you act.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. The lawful version of a ‘guaranteed return’ is a registered product with disclosed risk; check the seller free on FINRA BrokerCheck, the SEC adviser search, NFA BASIC or FinCEN’s MSB registry before sending anything.
  2. Ask in writing where returns come from, who holds the money and whether you can withdraw everything today; returns paid from new investors’ money mark a Ponzi scheme, as the SEC alleged in the $1.7 billion HyperFund case.
  3. Do not recruit for pay: inducing purchases of securities while unregistered breaches 15 U.S.C. §78o(a), and buyers can sue sellers who solicited for their own gain (Pinter v. Dahl, 1988).
  4. Treat ‘guaranteed’, requests to pay a personal wallet, recruiting rewards and withdrawal ‘fees’ or ‘taxes’ as stop signs; Investor.gov advises being highly suspicious of any guaranteed investment opportunity.

MaterialsInvestor.gov’s page on Ponzi schemes and their red flagsSEC press release 2024-11, on the HyperFund caseFINRA BrokerCheck, the SEC’s investment adviser search, the NFA’s BASIC database, or your own country’s regulator register15 U.S.C. §78o(a), on registration of brokers and dealers

Wonder

  1. What do pitches that end in court have in common?
  2. Can someone who only recruits or promotes be sued or charged?
  3. How can I check a person or an offer in a few minutes?

Explore

  1. A pitch that ends in court rarely looks like a crime at the start. It looks like an opportunity with a story: mining, arbitrage, a trading system, a new token. The SEC’s investor education site lists warning signs that recur in Ponzi cases, including high returns with little or no risk, overly consistent returns, unregistered investments, unlicensed sellers, secretive or complex strategies, issues with paperwork and difficulty receiving payments. It adds a blunt line: be highly suspicious of any ‘guaranteed’ investment opportunity. Lesson 4.2.6 explains how Ponzi schemes work and collapse; this lesson is about recognising the pitch before you are inside one.
  2. HyperFund shows the pattern. On 29 January 2024 the SEC charged its founder, Xue Lee, known as Sam Lee, and a top promoter, Brenda Chunga. According to the complaint, from June 2020 to early 2022 they sold HyperFund ‘membership’ packages that they claimed guaranteed high returns, pointing to supposed crypto mining operations and ties to a Fortune 500 company. The SEC alleged it was a pyramid scheme with no real source of revenue other than investors’ money, which raised more than $1.7 billion before withdrawals stopped in 2022. Chunga settled with the SEC and pleaded guilty to conspiracy to commit securities fraud and wire fraud; the SEC said its case against Lee would be litigated.
  3. Many pitches borrow trust from somewhere else: a community, a course, a famous name or a technical-sounding strategy. On 2 February 2024 the SEC announced that Brian Sewell, who ran an online crypto trading course called the American Bitcoin Academy, had agreed to settle fraud charges. The SEC alleged that he urged people taking his course to invest in a hedge fund he said he would launch using advanced trading strategies, took about $1.2 million from 15 of them, never launched the fund, and held the money in bitcoin that was later stolen when his wallet was hacked. Teaching and selling from the same platform is a pattern worth noticing.
  4. The law does not stop at the founder. Section 15(a) of the Securities Exchange Act, 15 U.S.C. §78o(a), makes it unlawful for an unregistered broker or dealer to use interstate commerce to effect transactions in, or induce or attempt to induce the purchase or sale of, a security. Recruiters paid for each sale of an investment that is a security may fall within that rule, and buyers of unregistered securities can sue people who solicited their purchase for their own financial gain (lesson 5.3.2, on Pinter v. Dahl). Wire fraud and state laws apply too (lesson 7.3.5). A scheme that rewards recruiting puts the people sharing it at legal risk, not only its founders.
  5. Some words in a pitch carry legal weight. Promises of profit from the work of a team are the language that can make an offer an investment contract (lesson 5.1.3), and returns paid mainly out of new members’ money are the defining feature of a Ponzi or pyramid scheme. Other signs suggest a seller avoiding the checks a lawful offering would accept: pressure to act fast, rewards for recruiting, requests to pay into a personal wallet, insistence that the offer is ‘not a security’ or ‘not regulated’, and withdrawal delays blamed on ‘fees’ or ‘taxes’ (lesson 4.2.5). No single sign proves fraud; several together predict trouble.
  6. A short routine fits most pitches. First, look up the person and firm: FINRA BrokerCheck and the SEC’s investment adviser search for securities, the NFA’s BASIC database for futures and commodity firms, FinCEN’s money services business registration search for exchanges and transmitters, and your state securities regulator; other countries keep their own registers. Second, ask in writing where the returns come from and who holds the money, and compare the answer with on-chain data where you can (lesson 6.3.3). Third, ask whether you could withdraw everything today. A vague answer to any of these is reason enough to stop. This lesson explains warning signs; it does not judge any particular offer.

Key facts

  • Investor.gov lists high returns with little or no risk, overly consistent returns, unregistered investments and unlicensed sellers among the red flags of Ponzi schemes.
  • Investor.gov advises being highly suspicious of any ‘guaranteed’ investment opportunity.
  • On 29 January 2024 the SEC charged HyperFund’s founder and a top promoter over an alleged crypto pyramid scheme that raised more than $1.7 billion.
  • The SEC alleged that HyperFund had no real source of revenue other than funds received from investors.
  • On 2 February 2024 the SEC announced that the operator of the American Bitcoin Academy course agreed to settle fraud charges over about $1.2 million taken from 15 participants.
  • 15 U.S.C. §78o(a) makes it unlawful for an unregistered broker or dealer to induce or attempt to induce the purchase or sale of a security through interstate commerce.

Exercise nine, six, three, one

9CollectList up to 9 phrases or features from a crypto investment pitch you have received or can find in an ad, post or group chat (some lists are shorter).
6ClusterSort them into 6 categories: return promises, borrowed trust (community, course or famous name), urgency and pressure, recruitment rewards, payment and withdrawal terms, and claims about regulation.
3DistillReduce the 6 to 3 groups: features that are legal warning signs on their own, features that only matter in combination, and features you could check against a register or the blockchain.
1CrystallizeWrite 1 sentence naming the single check you would run first on the next crypto investment pitch you receive, and why.

Fact check

Dates, figures and claims checked against the published sources listed below.

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