A federal judge has ordered a Texas man and his company to pay more than $40 million in disgorgement and civil penalties for operating a Ponzi scheme using the virtual currency Bitcoin. U.S. Magistrate Judge Amos L. Mazzant handed down the order against Trendon T. Shavers and his company, Bitcoin Savings & Trust ("BST"), stemming from an unopposed motion for summary judgment filed earlier this year by the Securities and Exchange Commission, which brought the original charges against Shavers and BST back in July 2013.
According to the Commission, Shavers, known as Pirateat40 on popular Bitcoin Forum Bitcointalk.org, began soliciting investors to park their Bitcoins ("BTC") in BST, a digital hedge fund that promised weekly returns of up to 7%. When asked how he was able to achieve such lucrative returns, Shavers told investors that he was involved in bitcoin arbitrage activity that included acting as a middleman for individuals who wished to purchase large quantities of BTC "off the radar." Shavers later expanded on this explanation, saying
“If my business is illegal then anyone trading coins for cash and back to coins is doing something illegal. :)”
When further asked about his profit margins, Shavers indicated that he achieved gross returns of nearly 11% per week. As the operation progressed, the minimum investment amount was raised to 100 BTC, and investors were permitted to re-invest their profits.
In July 2012, the scheme was estimated to have raised hundreds of thousands of BTC, which then had an average price of approximately $7 per BTC. However, Shavers announced in a post that the interest rate would decrease to 3.9% weekly beginning August 1, 2012, and began making preferential payouts to friends and longtime investors. Later that month, Shavers declared default:
As much as I've tried to meet the deadlines within the community, there're conditions beyond my control which have escalated the process to the point it is today. Bitcoin Savings & Trust has hereby given notice of default to its account holders.
The decision was based on the general size and overall time required to manage the transactions. As the fund grew there were larger and larger coin movements which put strain on my reserve accounts and ultimately caused delays on withdraws and the inability to fund orders within my system. On the 14th I made a final attempt to relieve pressure off the system by reducing the rates I offered for deposits. In a perfect world this would allow me to hold more coins in reserve outside the system, but instead it only exponentially increased the amount of withdrawals overnight causing mass panic from many of my lenders.
However, according to the Commission, Bitcoin Savings and Trust was nothing more than an elaborate scam that Shavers used to take in millions of dollars in BTC. Shavers took in more than 700,000 BTC, returning approximately 500,000 BTC to investors through purported returns of interest or principal. Of the remainder, Shavers transferred approximately 150,000 BTC - approximately $1 million based on the average price during that time period - to his personal account, which he used for a variety of unauthorized personal expenses including rent, car-related purchases, and gambling. Shavers also attempted his hand at arbitrage, selling the BTC's for dollars and vice-versa, but suffered losses.
Shavers contested the SEC's charges against him, and argued that he was not subject to the federal securities laws because bitcoin could not be classified as a "security." That argument was rejected by Judge Mazzant and later affirmed by the District Court, which both found that Bitcoin investments satisfied the test espoused by the Supreme Court in S.E.C. v. W.J. Howey & Co., 328 U.S. 293 (1946).
The Commission's Motion for Summary Judgment sought to impose penalties and disgorgement of approximately $40 million based on the average price of Bitcoin from the scheme's collapse to the present. Judge Mazzant adopted this methodology, and ordered that BST and Shavers must disgorge $38.6 million in ill-gotten gains, as well as approximately $1.8 million in prejudgment interest. In addition, both BST and Shavers were ordered to pay a civil monetary penalty of $150,000 each for their "egregious" conduct.