ICO of DROPs Is A Fraud SEC Alleges
Offering frauds have long been the focus of Commission Enforcement. The cases typically center on raising money through the sale of promissory notes, interests in a firm, investments in a future string of medical clinics and other items.
The most recent action in this area is based on a digital currency, known as the DROP, that was traded by a bot and supposedly brought in over $54 million from investors during the initial coin offering. DROPS could be acquired using a variety of digital currencies and of course cash. Regardless of the medium of payment, the offering ended the same as many others for the investors, badly. SEC v. Dropil Inc., Civil Action No. 8:20-cv-00793 (C.D. CA. Filed April 23, 2020).
Jeremy McAlpine, Zachary Matar, and Patrick O’Hara, each a co-founder of Dropil, are named as defendants along with their firm. In late 2017 Defendants launched an initial offering for DROPs on Dropil’s website. The White Paper used to promote the offering appeared the following January.
The White Paper claimed that DROPs could be acquired using a variety of digital assets. The Paper also claimed that Dropil’s “primary service” was a carefully curated and tested set of automated trading bots created by the firm. All transactions by the firm were in the Dex system which required the use of DROP tokens.
Investors who wanted to combine the benefits of algorithm trading and holding coins would do well to invest, the White Paper claimed. Investor funds would be pooled, allowing maximum diversification – a large advantage for all traders. The stable returns from the coins would provide good returns. The offering was marketed not just through the White Paper but also on the firm website and social media.
At the conclusion of the initial month long phase of the offering in early March 2018, the firm had about 2,472 investors who purchased 629,561 DROPs in 3,451 transactions. There were no qualifications for investors.
After the initial offering, Defendants continued to market and sell DROPs. Over a period of several months Dropil obtained digital assets worth at least $683,747 from those sales. About $390,387 were in digital assets transferred to the founders’ personal accounts at the digital asset trading platform Coinbase.
The offering was based on a series of false statements. First, the post offering press release detailing the results was incorrect. It falsely claimed that the firm had sold over 1 billion DROPs. Later there were claims of 50,000. That representation was also incorrect.
Second, a key point of the sales centered on trading by the bots. While supposedly Dex was engaged in ongoing, profitable trading, in fact it functioned for only a brief period. Third, while investors were supposed to profit from Dex’s trading and the investments in fact that was not true. There were no trading profits; any payments came from other sources. Fourth, Defendants misused investor funds. Dropil was supposed to fund capital expenses and pay its founders through DROPs it retained. In fact, of the nearly $1.9 million raised in the ICO, about $1.3 million was transfers to the personal digital asset holdings of the firm’s three co-founders. Finally, Defendants made efforts to conceal their activities by, for example, fabricating documents in response to staff subpoenas.
The complaint alleges violations of Exchange Act Section 10(b), and Securities Act Sections 17(a), 5(a)and 5(c). The case is pending. See Lit. Rel. No. 24804 (April 24, 2020).