by T. GormanPosted on Posted in SECActions

Crypto assets at times appear to be an everchanging landscape where a new coin or asset appeari almost every moment. As fast as those new coins or assets appear, there also seems to be a new person who knows how to take advantage of investors with a slick new scheme. This is the stuff the Commission’s latest enforcement action is built of – a new crypto asset that ends up as the center piece of a “Rug Pull” – SEC v. Zhu, Civil Action No. 3:25-cv-00054 (M.D.L.A. Filed Jan. 16, 2025).

Defendant Eric Zuh is a freelance blockchain engineer residing in New York. He was retained to provide technical assistance in connection with a new crypto asset known as GME. Game Coin, LLC, is a Louisiana based firm formed in August 2021 for the purpose of developing a website-based marketplace that would permit amateur athletes to create digital trading cards. Individual 1 and Individual 2 worked largely in the landscaping business.

From June 2021 through September of the same year Defendant Eric Zhu participated in the creation of a new game token that would be offered and sold as a crypto asset security to investors. Individual 1 and 2 had contemplated the creation of a new crypto asset that was designed to serve as a medium of exchange for digital trading cards available for sale on the marketplace. The new asset, called GME, was promoted on social media. Investors were promised that a marketplace would be built so they could use GME to buy digital trading cards of amateur athletes. Mr. Zhu, an experienced blockchain engineer, was retained to perform coding work for the offer and sale of GME to the public.

Over a period of several months, beginning in June 2021, Individual 1 and Individual 2 sold GME to investors through a crypto asset trading platform known as PancakeSwap. The firm facilitated the transactions through the creation of what were called liquidity pools – pools of assets that could be exchanged for each other.

In June 2021 Individual 1 and Individual 2 launched the public sale of GME by establishing a PancakeSwap liquidity pool that enabled investors to buy and sell GME. They also arranged for a crypto asset known as Binance Coin or BNB, to serve as the initial liquidity for the GME Liquidity Pool. Investors could interact with GME Liquidity Pool, buying GME and depositing BNB or selling GME and withdrawing BNB. A person who deposited a crypto asset token pair into the Liquidity Pool received a “liquidity provider” token or LP token. Those tokens had risk however since the LP token holder could sell off large volumes of them.

Individual 1 and Individual 2, in view of the risks, represented in social media posts that there were safeguards such that liquidity was locked – the LP tokens could not be used by issuers or insiders to withdraw liquidity in a rug pull-like fashion.

Mr. Zhu was aware of the risks. He kept LP tokens unlocked, something that was not known to others. He then withdrew GME and BNB from the Liquidity Pool. Mr. Zhu t used the unlocked LP tokens to withdraw GME and misappropriate crypto assets worth about $553,000 – essentially, he did what traders call a rug pull. The value of the assets declined in price by 12%.

The Commission’s complaint alleged violations of Securities Act Sections 17(a)(1) and 17(a)(3) as well as Exchange Act Section 10(b) and Rule 10b-5. Mr. Zhu resolved the matter by consenting to the entry of permanent injunctions based on the Sections cited in the complaint. He also agreed to pay disgorgement and prejudgment interest of $672,992 and a civil penalty of $150,000. See Lit. Rel. No. 26223 (Jan. 16, 2025).

Tagged with: , ,

by T. GormanPosted on Posted in SECActions

Provisions such as Section 13(d) were added to the Exchange Act to provide the markets and investors with notice of those who have significant holdings of a security. The Section requires that those who acquire 5% or more of a security file a form disclose their holdings and intention. The Section has a strict liability standard – traders must comply with the dictates of the Section, no excuses. The Commission’s latest case in this area names Elon Musk as a defendant. SEC v. Musk, Civil Action No. 25-cv-105 (D.D.C. Filed January 14, 2025).

Mr. Musk is, of course, a well-known celebrity. In March 2022 he began purchasing shares of Twitter common stock. By March 14, 2022, he had acquired beneficial ownership of over 5% of the firm’s outstanding common shares.

During the period Exchange Act Section 13d-1 required Mr. Musk to file with the Commission a beneficial ownership report disclosing his transaction within ten calendar days after crossing the 5% level. He did not. By not filing Mr. Musk save over $150 million, according to the Commission. Mr. Musk’s gains were the losses for other traders in the market as he traded.

On April 4, 2022, Mr. Musk publicly disclosed his beneficial ownership in a report filed with the Commission. The filing disclosed that he had acquired over 9% of the shares. Following the announcement the share price increased by over 27% over the prior day’s close. By not complying with Section 13(d) Mr. Musk saved over $150 million. He spent over $500 million to acquire the block of stock. The complaint alleges violations of Exchange Act Section 13(d). See Lit. Rel. No. 26219 (January 14, 2025).

There is little doubt that Mr. Musk knew about Section 13(d). So, the question is this: What was Mr. Musk’s point?

Tagged with: , ,