A federal judge this week may have added some clarity to whether initial coin offerings fall under securities law after issuing a first-of-its-kind ruling in a criminal context.

In a case out of the Eastern District of New York, U.S. District Judge Raymond Dearie ruled that securities law is fair game in prosecuting cryptocurrency fraud. Dearie's ruling rebuffed a motion to dismiss filed by defense counsel for Maksim Zaslavskiy. The judge denied that cryptocurrencies are “expressly excluded” from being defined as a security, an argument buttressed by existing case law, defense counsel argued.

The ruling marks among the earliest instances of a federal judge weighing in on how an ICO can be regulated. Its potential to shape regulatory oversight and litigation are already being discussed by experts, many of whom disagree on its significance.

And while the ruling is by no means the first application of securities laws on the nascent marketplace, but some believe it may be “a bit of a bellwether.”

Benjamin Klein, an associate at DLA Piper, who represents clients in cryptocurrency investigations by the U.S. Securities and Exchange Commission and Department of Justice, said a lot of companies and advisers were watching for the judge's ruling.

“This is the groundwork for future prosecution and enforcement action for the SEC and DOJ,” Klein said. “This is the first case where they're really testing this theory as to whether a digital asset or token qualifies as an investment contract, and therefore offers and sales are subject to U.S. security laws. This situation is the first one where the question is really before the judge in an action brought by the U.S. federal government.”

Klein said “the ultimate question” of whether digital tokens will be considered securities is up to a jury, and could “embolden the DOJ or SEC to purse similar cases.”

Kein added that he suspects there's a lot of enforcement activity waiting in the pipeline, noting that much of what the agencies focus on are “low hanging fruit cases” that are “ripe with allegations of fraud or abuse.”

A Place Amid Increasing Regulation

While cryptocurrency market regulation is far from nonexistent, the arena isn't known for its stringency. Writing in Bloomberg BNA, Orrick, Herrington & Sutcliffe of counsel Jason Somensatto said enforcement has been “minimal,” but noted that should change as regulators increase their attention on marketplace issues.

In September, the SEC made what Business Insider claimed was its “first-ever actions against a crypto hedge fund.” In another first, the Financial Industry Regulatory Authority took action against HempCoin, an unregistered security. Recent research by Lex Machina indicates that in the U.S., securities lawsuits filed over bitcoin or cryptocurrency tripled this year, The National Law Journal reported, with the SEC responsible for 30 percent of the cases filed as of June 30.

SEC Chairman Jay Clayton has said “by and large, the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws.”

While the ICO marketplace is in a period of transition, some experts assert the Dearie ruling is a step toward greater enforcement rather than a tipping point. O'Melveny & Myers partner Eric Sibbitt said it's important because it signals the pursuit of criminal actions in the cryptocurrency space.

“I don't think it by itself changes the landscape dramatically. I think the same risk that existed before continues to exist, and people are going to try to navigate those despite the lack of regulatory clarity in those areas,” said Sibbitt, who also chairs the firm's financial technology practice.

In Sibbit's view, there's a “need to find who the primary regulator is,” as well as “draw some boundaries” around who enforces what.

His colleague, Laurel Rimon, O'Melveny senior counsel and former GC for the Office of Inspector General at the Department of Homeland Security, considers Dearie's decision to be “a nudge toward the regulators” regarding who regulates what.

There's “been some overlap” between the SEC and other agencies regulating ICOs, she said. With “technology in regulations, there should be overlap of regimes, but it's not clear where that line is in this context,” Rimon said. This opinion, she said, won't clarify that line.

It “puts it on the map in the context of a criminal case, so it gives it more of a pointedness, but doesn't provide any clarity to that issue.”

But not everyone sees the ruling as groundbreaking.

Anderson Kill partner Stephen Palley, a co-chairman in the firm's blockchain and virtual currency group, said he “wouldn't read too much precedential value in to this opinion,” noting it's fairly clear that “if you flat out use the pretext of token sales to steal from people, you're going to get charged with a securities fraud.”

“I don't think this is really groundbreaking legal precedent. The court does something lawyers that follow this space have said for a long time … tokens can be investment contracts. They can be a security. If you commit criminal fraud in connection with a securities offering, you can be charged and go to prison,” he said. “The court said you can call it a thread, you can call it a chicken, but if it's a security, it doesn't matter what you call it.”

Joe Dewey, a Holland & Knight partner who's also a receiver in an SEC case where $20 million of cryptocurrency was stolen during a hack, said the level of fraud detailed in the Zaslavskiy complaint “is not uncommon.”

“Unfortunately, there are a fair amount of bad actors in this space,” he said. The Zaslavskiy decision “may limit or dissuade a defendant to try to bring this kind of defense again. … But then again, these are all facts and circumstances cases, so it's hard to have great precedent that doesn't have to be bespoke applied.”