Commodity Futures Trading Comm'n v. McDonnell

287 F.Supp.3d 213

COMMODITY FUTURES TRADING COMMISSION, Plaintiff,

v.Patrick K. MCDONNELL, and CabbageTech, Corp. d/b/a Coin Drop Markets, Defendants.

18–CV–361

United States District Court, E.D. New York.

Signed March 6, 2018

Commodity Futures Trading Commission: David William Oakland, Commodity Futures Trading Commission, 140 Broadway, 19th Floor, New York, NY 10005, Email: doakland@cftc.gov, Kenneth B. Tomer, Commodity Futures Trading Commission, 140 Broadway, 19th Floor, New York, NY 10005, Email: ktomer@cftc.gov, Gates Salyers Hurand, Commodity Futures Trading Commission, 140 Broadway, 19th Floor, Ny, NY 10005, 646–746–9700, Fax: 646–746–3903, Email: ghurand@cftc.gov.

Patrick McDonnell, CabbageTech Corp., d/b/a/ Coin Drop Markets, Pro se.

MEMORANDUM & ORDER

Jack B. Weinstein, Senior United States District Judge:

Table of Contents

I. Introduction...216

A. Commodity Futures Trading Commission ("CFTC") Standing ...217

B. Injunctive Relief...217

II. Facts...217

III. Background of Bitcoin and Virtual Currencies...218

A. Description of Virtual Currencies...218

B. Expansion and Value...218

C. Fraud and Crime...219

D. Regulation and Oversight of Virtual Currency...220

1. Potential Virtual Currency Regulation...220

2. Oversight by CFTC...221

3. Concurrent Oversight from Other Agencies...222

IV. Law...223

A. Jurisdiction...223

B. Standing...223

1. Enforcement Power of CFTC...223

a. Virtual Currencies are Commodities...224

b. Commodity Exchange Act's Definition of "Commodity"...225

c. CFTC's Interpretation of "Commodity"...226

d. Derivative Contracts and Futures...226

e. Regulation of Spot Market Fraud...227

2. Concurrent Jurisdiction...228

C. Preliminary Injunction Standard...228

V. Application of Law...228

A. CFTC Standing...228

1. Virtual Currencies as Commodities...228

2. CFTC Jurisdiction Over Virtual Currency Fraud ...229

B. Prima Facie Showing of Fraud Committed by Defendants...229

C. Preliminary Injunction...230

D. Appropriate Research by Court...230

VI. Conclusion...230

VII. Appendix A Preliminary Injunction...231

VIII. Appendix B CFTC Primer...231

IX. Appendix C Congressional Testimony of CFTC Chairman...233

I. Introduction

The Commodity Futures Trading Commission ("CFTC") sues Patrick McDonnell and his company Coin Drop Markets. CFTC alleges defendants "operated a deceptive and fraudulent virtual currency scheme ... for purported virtual currency trading advice" and "for virtual currency purchases and trading ... and simply misappropriated [investor] funds." See CFTC Complaint, ECF No. 1, Jan. 18, 2018, at 1 ("CFTC Compl.").

CFTC seeks injunctive relief, monetary penalties, and restitution of funds received in violation of the Commodity Exchange Act ("CEA"). Id. at 11.

Until Congress clarifies the matter, the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealings in virtual currency. An important nationally and internationally traded commodity, virtual currency is tendered for payment for debts, although, unlike United States currency, it is not legal tender that must be accepted. Title 31 U.S.C. § 5103 ("United States coins and currency ... are legal tender for all debts ...").

A. Commodity Futures Trading Commission ("CFTC") Standing

The primary issue raised at the outset of this litigation is whether CFTC has standing to sue defendants on the theory that they have violated the CEA. Title 7 U.S.C. § 1. Presented are two questions that determine the plaintiff's standing: (1) whether virtual currency may be regulated by the CFTC as a commodity; and (2) whether the amendments to the CEA under the Dodd–Frank Act permit the CFTC to exercise its jurisdiction over fraud that does not directly involve the sale of futures or derivative contracts.

Both questions are answered in the affirmative. A "commodity" encompasses virtual currency both in economic function and in the language of the statute. Title 7 U.S.C. § 1(a)(9) (The CEA defines "commodity" as agricultural products and "all other goods and articles ... and all services, rights, and interests ... in which contracts for future delivery are presently or in the future dealt in.").

CFTC's broad authority extends to fraud or manipulation in derivatives markets and underlying spot markets. See Title 7 U.S.C. § 9(1). CFTC may exercise its enforcement power over fraud related to virtual currencies sold in interstate commerce. See Title 17 C.F.R. § 180.1.

B. Injunctive Relief

After hearing testimony from an investigator in the Division of Enforcement for the CFTC, the court finds the plaintiff has made a preliminary prima facie showing that the defendants committed fraud by misappropriation of investors' funds and misrepresentation through false trading advice and promised future profits.

A preliminary injunction is granted in favor of the CFTC. The court finds a reasonable likelihood that without an injunction the defendants will continue to violate the CEA. An order outlining the terms of relief is issued and attached. See Appendix A, Order of Preliminary Injunction and Other Relief ("App. A, Prelim. Injunction").

II. Facts

Patrick McDonnell and his company CabbageTech, Corp., doing business as Coin Drop Markets ("defendants"), offered fraudulent trading and investment services related to virtual currency, see Description of "Virtual Currencies" infra Part III, in the spring and summer of 2017. Christopher Giglio Declaration, ECF No. 21, Feb. 26, 2018, Ex. 2 ("Giglio Decl.") ¶¶ 13,14.

Customers from the United States and abroad paid defendants for "membership" in virtual currency trading groups purported to provide exit prices and profits of up to "300%" per week. Id. ¶¶ 17–20. Defendants advertised their services through "at least two websites, www.coindropmarkets.com and www.coindrops.club," as well as on the social media platform Twitter. Id. ¶¶ 15–17.

"Investors" transferred virtual currency to the defendants for "day" trading. Id. ¶ 21 ("McDonnell claimed that he could generate profits of 2 to 300% each day for [an] Investor ... and that $1,000 in Litecoin [a type of virtual currency] should be earning $200 to $250 per day through trading.").

After receiving membership payment or virtual currency investments, defendants deleted their "social media accounts" and "websites and ceased communicating with ... customers around July, 2017." Id. ¶ 26. Defendants provided minimal, if any, virtual currency trading advice and never achieved the promised return on investment. Id. ¶ 27. When customers asked for a return of their membership fee, or virtual currency investment, the defendants refused and misappropriated the funds. Id. ¶¶ 27–32.

III. Background of Bitcoin and Virtual Currencies

A. Description of Virtual Currencies

Virtual currencies are generally defined as "digital assets used as a medium of exchange." Skadden's Insights, Bitcoins and Blockchain: The CFTC Takes Notice of Virtual Currencies , Jan., 2016. They are stored electronically in "digital wallets," and exchanged over the internet through a direct peer-to-peer system. Id. They are often described as "cryptocurrencies" because they use "cryptographic protocols to secure transactions ... recorded on publicly available decentralized ledgers," called "blockchains." Brief of CFTC In Support of Preliminary Injunction and Other Relief, ECF No. 21, Feb. 26, 2018, at 4 ("CFTC Brief").

The "blockchain" serves as a digital signature to verify the exchange. See Appendix B, A CFTC Primer on Virtual Currencies , Oct. 17, 2017, at 5 ("App. B, CFTC Primer "). "The public nature of the decentralized ledger allows people to recognize the transfer of virtual currency from one user to another without requiring any central intermediary in which both users need to trust." CFTC Brief, at 4. Some experts believe blockchain technology underlying virtual currencies will serve to "enhance [future] economic efficiency" and have a "broad and lasting impact on global financial markets in payments, banking, securities settlement, title recording, cyber security and trade reporting and analysis." Appendix C, United States Senate Banking Committee, Hearing on Virtual Currency, Feb. 6, 2018 (written testimony of Christopher Giancarlo, Chairman, CFTC) ("App. C, CFTC Chair, Congressional Testimony"). Virtual currencies are not backed by any government, fiat currency, or commodity. Robert J. Anello, New–Wave Legal Challenges for Bitcoin and Other CryptoCurrencies , Law Journal Newsletters, Nov. 2017.

They have some characteristics of government paper currency, commodities, and securities. Allison Nathan, Interview with Eric Posner , Goldman Sachs Global Investment Research, Mar. 11, 2014 ("It is a lot like gold, in fact. The difference [ ] is that it is digital rather than a heavy, unwieldy object. That means that it could serve the same purposes as gold in terms of a currency, but much more efficiently because it does not have any mass and can be sent easily from place to place."); cf. Power of the Executive to Change the Gold Value of the Dollar , Columbia Law Review, Vol. 48, No. 3 (Apr. 1948) ("[T]he United States is committed to a policy of international cooperation, and in particular, to a program of international stability of [currency] exchange rates ...").

B. Expansion and Value

The price of Bitcoin, and other virtual currencies, has risen, and then fallen, at extreme rates. Olga Kharif, All you Need to Know About Bitcoin's Rise, From $0.01 to $15,000 , Bloomberg Businessweek, Dec. 1, 2017 ("The initial price of bitcoin, set in 2010, was less than 1 cent. Now it's crossed $16,000. Once seen as the province of nerds, libertarians and drug dealers, bitcoin today is drawing millions of dollars from hedge funds.").

As their value has increased, online exchanges have become more accessible allowing more members of the public to trade and invest in virtual currencies.

While there are many Bitcoin exchanges around the world, Coinbase has been the dominant place that ordinary Americans go to buy and sell virtual

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