USA: Crypto “shake downs”

Date: 22 Feb 2022

Silvia Ricciardi

Crypto criminals face years in pre-trial detention and millions in legal fees

As bitcoin has become a brand and celebrity, whether approved of or not, in turn so have people in the space. Some for good reasons like Tyler and Cameron Winklevoss who famously fell out with Mark Zuckerberg of Meta formerly known as Facebook, who then went big with bitcoinand are now worth $billions. However, in a recent high-profile case which made world headlines, Ilya Lichtenstein a tech entrepreneur with dual Russian-US citizenship and his wife Heather Morgan were arrested on February the 8th for being instrumental in one of the largest crypto heists ever recorded. In 2016 the Bitfinexexchange was hacked of 119,754 bitcoin which was worth around $71million at the time but is now worth $4.5billion. Federal officials seized 94,000 of the stolen bitcoin, with an estimated value of $3.6 billion and later released Heather Morgan. Andrey Spektor, Partner, Bryan Cave Leighton Paisner, New York tells us why.”As far as the government has revealed so far, the evidence against Morgan is not as strong as it is against Lichtenstein.The defense previewed the potential argument from both defendants especially Morgan: She received money but did so unwittingly, and that is not considered a criminal,” Spektor, who speaks Russian and represents companies, boards of directors, and individuals in criminal actions and government investigations says “the government could always uncover or reveal more, but so far, it appears that the evidence is stronger on him. He is more culpable. The DOJ will have to show Morgan had knowledge of the crime.”

Conviction is not a foregone conclusion

Despite the headlines, the government’s case may be challenging, as there don’tappear to be witnesses or other traditional evidence of a crime, at least based on what the government has so far revealed. “Having a married couple for defendants is a challenge,” Says Spektor, “since it’s unlikely that one spouse will testify against the other. There will undoubtedly beevidentiary hurdlesfor the government to clear at trial; as this hotly litigated bail proceeding has already shown, this will be a litigious case.The government lost round #1 in the SDNY (Southern District of New York), with the magistrate judge releasing the defendants for purposes of their appearance in D.C., where they will be tried, but, in an unusual move, declining to stay her order, releasing them before an appeal could be heard. The government filed an emergency appeal in the D.C. district court, where the case was indicted, and a chief judge in that court overruled the SDNY’s judge’s decision, ordering the defendants to be transported in custody. When they appeared in D.C., the judge released Morgan on strict conditions, but detained Lichtenstein.”

Spektor says of this case and crypto generally that there is a growing interest from the US government because of the rise in the value of bitcoin and other crypto currencies. “For instance, the Ripple lawsuit, where the company is currently valued at $15 Billion, they are in a huge battle with the SEC over whetherXRPthe Ripple native coin isa security or not;which, in that case, boils down to whether XRP isan investment contractor currency. The SEC says it’s the former.” Spektor continues, “Prosecutors may like big, aggressive actions but you need more regulation not enforcement.” Lisa Monaco Deputy Attorney General, the second most powerful position in the Department of Justice (DOJ), seems to favor the latter, with her recent announcement that the department was launching a new National Cryptocurrency Enforcement Team.

Spektor explains that the reason Lichtenstein has been detained despite initially being released for purposed of appearing in DC is that prosecutors can proceed “by proffer” at bail hearing, meaning they can generally describe the evidence they have, without showing all their cards. Chief US District Judge Beryl A. Howell, of the District of Columbia, wasimpressed with this proffer, at least as to Lichtenstein, calling the government’s evidence “so weighty as to be overwhelming.”She ordered Lichtenstein held at the DC jail to defend himself from charges of money laundering and conspiracy.Spektor adds, “The couple knew they were being investigated since January. Whilst most arrests are a surprise this was not, in fact the defense attorneys used this saying because the couple knew and didn’t run, they were not a flight risk. However, the counter argument was that they thought in January that they would avoid prosecution, but the position had now become very different.”

United States v. Potekhin also known as Cronuswar

The pre-trial detention decision may also have been based on experience from a case by the United States v. Potekhin also known as Cronuswar. Russian nationals were charged with conspiring to defraud multiple crypto exchanges and their customers. In July 2017, Potekhin created and controlled at least 13 separate fake domains inducing more than 150 victim customers of their exchange to input their user identification and passwords. This case involves sophisticated, cross-border fraud schemes to steal crypto, and then inflate its price with theft and manipulation at a minimum of $16.8 million in cryptocurrency. Potekhin remains at large and can be found on the current US sanctions list.

Legal experts say that defending an individual in a criminal prosecution is expensive, ranging from about $100K for a case where there is an early guilty plea, to millions of dollars for complex federal case that proceeds to trial. And that this isall separate from forfeiture payment, which is money the government takes from the defendant as proceeds of a crime; restitution, which is money taken from victims and redistributed back to them by the government; and criminal fines and penalties.

Burner Phone

Spektor saysthat during the bail proceedings, law enforcement revealed that it had seizeditems from the defendants’ house that could be “a treasure trove” of incriminating evidence, such as items that could be used to conceal their whereabouts and facilitate flight to foreign countries, including bags containing multiple cell phones and SIM cards, one of which was labelled ‘Burner Phone,’ as well as a substantial amount of foreign currency. Spektor says that locked Apple iPhones have given the government problems in the past in getting in, but in most cases the government can crack the phone to access its content. “The government has played catch up with Apple, and its encryption abilities.” Spektor added that the contents of the phone could be invaluable: “A prosecutor dream is a phone with incriminating messages because it helps convince jurors of guilt. An incriminating conversation by or between the two defendants could be a slam dunk at a jury trial.That is especially important in this case because, as the defense points out, there are no wiretaps or other forms of recorded communications that one might expect in a case like this.”

As to the time lag with Bitfinex: the hack happened in 2016, Spektor says. “The government said it now has its own tools to track stolen crypto. One interesting thing to watch for is that the government doesn’t want to show its tools. They essentially said in their submissions: ‘we don’t want to share our techniques.'” However, he says it won’t work for the trial as they have to convince regular folks of Lichtenstein’s guilt and show their evidence. “So, they are going to have to show how they traced this money. It will be a real problem.” Spektor explains, “As prosecutors and agents continue to get educated in digital currency, their cases become more challenging. Federal agents may convince a federal judge, on a probable cause, to sign search warrants, but prosecutors will have to explain blockchains, NFTs, and tracing analysis to 12 laypeople who sit on a jury, people who may never have even heard of cryptocurrency. Experienced trial attorneys who understand crypto could make the government’s job of proving guilt beyond a reasonable doubt incredibly difficult.”

What are his thoughts for what will happen at the Lichtenstein trial? “For the defense, the natural instinct is to slow things down because there is a mismatch in the power dynamic: the government usually has a lot of evidence and the defense has to play catch up in reviewing it to mount a defense. But in crypto cases, the government is also scrambling, trying to figure things out and they may not be ready for at trial.” Spektor added that in federal criminal cases, defendants can ask for a speedy trial, which means the trial “could happen in a few months, but it’s unlikely.”

“The prosecution will need to get into that phone and any other electronic devices. What resonates with jurors is seeing the defendants’ own words. As a prosecutor, if you can stand up and show or play those words, whether it is an incriminating text message or a phone conversation, that is what often gets convictions.”

Spektor says crypto ‘crime’ falls into three buckets in his view: stolen crypto, fraud and ponzi schemes and existential lawsuits, like Ripple, though not a criminal case, but one that may determine how crypto is viewed. He adds that because Ripple is a civil case, it could take longer, as there is significant discovery and pre-trial briefing that occurs before resolution, and judges take months to make a ruling on any given motion. “They prioritize criminal over civil,” He says. “One of the early issues in the Ripple case is whether the individual executives should be dismissed or if they could be legally said to have been aiding and abetting a violation. So, the SEC will have to show some level of knowledge and intent by those individuals that they knew XRP was a security.” He adds that even if a judge or a jury ultimately determine that it is a security, there is no reason to believe the executives believed it was a security.” As for the timing of any resolution, Spektor says “unless there is a settlement it can go on for years.” Don’t count on the SEC just walking away from the case, which just changed leadership and appears happy to continue litigating it. Regulators like the SEC are loath to walk away from cases generally: “These cases take a long time to build,” Says Spektor.

Gary Gensler arrival

“It’s too early to see how Gary Gensler, the new chair of the U.S. Securities and Exchange Commission will act, though it seems clear that crypto is a priority and new regulations will come.” Perhaps there will be new laws passed, too, as Spektor npointed out that companies like Ripple and Coinbase are investing in lobbying congress. “Maybe in a year or so everything will make more sense, though you can count on there being more prosecutions because of the sheer amount of money at stake and because there are large numbers of victims.”

As to whether the USA will keep an eye on other jurisdictions for guidance, Spektor says no. “The US legal system is so complicated with the overlap of criminal cases, pseudo-criminal cases brought by the SEC, and private civil actions, which all contribute to the development of precedent, that regulators don’t pay too much attention to what is going on elsewhere. Congress looks internally to regulate and to be at the forefront of new crypto-related laws.”

Crypto ‘crime’ and white collar fraud may also just have just got a twist in its tail: as a prosecutor, Spektor was involved in a crypto lawsuit: the United States v. Nerayoff et al which is pending and set for trial later this year against Nerayoff (the other party Hlady pled guilty). Nerayoff, an attorney, and Hlady allegedly threatened to destroy a startup cryptocurrency company, specializing in loyalty tokens, on the eve of its ICO if they were not paid millions of dollars in the cryptocurrency Ether (ETH). Hlady pretended to be, among other things, a former agent with the CIA and FBI.

Whatever the irony is in that, it certainly won’t be lost on the SEC.

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