Antitrust Law Daily Wrap Up, CONSUMER PROTECTION—S.D.N.Y.: FTC action against executives of Celsius will proceed, (Dec 14, 2023)

By Martin A. Steinberg, J.D.

The executives of Celsius were either aware of Celsius' misconduct or were recklessly indifferent to the truth or falsity of its representations.

The federal district court in New York City denied the individual Defendants’ FRCP Rule 12(b)(6) motion to dismiss the FTC’s charges of continuing violations of § 5 of the FTC Act and the Gramm-Leach-Bliley Act (GLB Act), 15 U.S.C. §§ 6821 et seq., in connection with Defendants' marketing and sale of cryptocurrency lending and custody services. Individual Defendants Alexander Mashinsky, Shlomi Daniel Leon, and Hanoch Goldstein were executives with Celsius Networks (Celsius), a cryptocurrency financial services provider. The court held that the FTC adequately pleaded violations of the FTC Act. Additionally, because the same individual liability standard that applies under Section 5 of the FTC Act also applies to individual violations of the GLB Act, the FTC adequately alleged violations of the GLB Act (FTC v. Celsius Network Inc., December 12, 2023, Cote, D.).

Background. Celsius offered a variety of cryptocurrency products and services to its customers, including earning interest, or "rewards," on cryptocurrency deposits, issuing loans secured by their deposits, and storing their cryptocurrency on the platform. Customers also had the ability to swap, buy and transfer certain cryptocurrencies. When Celsius users created an account, they were required to provide personal information like a social security number and a copy of a government-issued identification. In many instances, Celsius obtained consumers' bank account information. Mashinsky and Leon co-founded the company in 2017. Additionally, Mashinsky, Leon, and Goldstein were, respectively, Celsius' Chief Executive Officer, Chief Operating Officer and Chief Strategy Officer, and Chief Technology Officer.

FTC allegations. The FTC filed suit on July 13, 2023, bringing three claims against Celsius, its related corporate entities, and the three individual Defendants: two for deception and unfair misappropriation of cryptocurrency deposits under § 5(a) of the FTC Act, and a third for violating the GLB Act. The corporate defendants had previously settled.

The complaint alleged that Defendants deceived users by misrepresenting the benefits of using Celsius services and the safety of consumer funds. Defendants allegedly falsely claimed that: (1) Celsius did not make unsecured loans; (2) Celsius maintained sufficient liquid crypto assets to satisfy its consumer obligations; (3) consumers could withdraw the cryptocurrency they deposited at any time; (4) Celsius maintained a $750 million insurance policy for consumer deposits; and (5) consumers could earn "up to 17% APY" and "up to 18.63% APY."

The complaint alleged that the representations the company and executives made were false or misleading. Contrary its executives' representations, the FTC asserted that Celsius (1) routinely made unsecured loans, totaling $1.2 billion as of April 2022, (2) maintained only a small capital reserve that would have allowed only a fraction of its customers to withdraw their crypto within one week, and (3) did not hold a $750 million insurance policy for deposits as advertised. They also failed to deliver the annual percentage yield (APY) they promised on consumers' cryptocurrency deposits. The complaint asserted that during the period that Celsius advertised APY up to 17% or more, less than 1% of Celsius customers earned rewards of 17%. The highest promised APYs were available only to customers who were enrolled in its "CEL Loyalty Program."

The FTC further alleged that Celsius took title to and transferred consumer cryptocurrency deposits into Celsius' pooled account. The company then used consumer deposits to fund its operations, pay rewards to other customers, and to stake or pledge collateral from other institutions. The individual Defendants each withdrew significant sums of cryptocurrency from Celsius in April and May 2022. By May 2022, the FTC claimed that Celsius was insolvent. The company's top executives concealed this information from the public, telling consumers that customers' deposits were safe and were still soliciting new customers.

On June 12, 2022, Celsius froze consumer accounts and denied consumers access to their assets. Celsius then filed for bankruptcy the next day. Most consumers have yet to regain access to their cryptocurrency.

On July 13, 2023, Celsius was permanently banned from handling consumers’ assets as part of a settlement of charges. The remaining charges against the individual defendants were before the court on motions to dismiss.

Violations of the FTC Act. The court denied the motions to dismiss the FTC Act claims against the individual defendants because the complaint adequately pleaded that Leon and Goldstein were aware of Celsius' misconduct or, at the very least, were recklessly indifferent to the truth or falsity of its representations. Individuals may be held liable for unfair or deceptive acts and practices when they participated directly in the practices or acts or had authority to control them and had or should have had known about the misconduct.

The court initially addressed the issue of whether claims under § 5 of the FTC Act are subject to FRCP Rule 8(a)'s liberal pleading standard or the heightened pleading standard of Rule 9(b). The court concluded that a § 5 claim is not a claim of fraud as that term is commonly understood or as contemplated by Rule 9(b). While the Second Circuit had not directly addressed this issue, its decision in Pelman v. McDonald's Corp., 396 F.3d 508 (2d Cir. 2005) was instructive. There, the court determined that because § 349 of the New York General Business Law and part of the New York Consumer Protection Act extends beyond common-law fraud to cover a broad range of deceptive practices it does not require the pleading-with-particularity requirements of Rule 9(b). Because the court found the state statute to be analogous to the FTC Act, the FTC did not need to prove scienter, reliance, or injury to establish a § 5 violation. Furthermore, courts in this district had consistently held that the FTC need only meet the bare-bones pleading requirements of Rule 8(a).

The complaint alleged sufficient facts to support individual liability for the FTC Act violations against both Leon and Goldstein. Leon is alleged to be a co-founder of the company and an executive officer of multiple Celsius entities. He served as President for one of the entities, and director of six Celsius entities. Leon allegedly served on numerous committees relevant to the misconduct alleged in the complaint, including the Assets and Liabilities Committee, Risk Committee, and Investment Committee. Goldstein is also alleged to have served as the company's Chief Technology Officer and sat on both the Executive Committee and Risk Committee. Moreover, Goldstein appeared in Celsius' marketing videos, one of the primary vehicles for Celsius' alleged deceptive practices. Mashinsky, on the other hand, did not dispute that the FTC had sufficiently alleged his individual liability for the FTC Act violations.

Injunctive relief. The court found that the facts alleged in the complaint were sufficient to plead entitlement to injunctive relief. To plead entitlement to a permanent injunction, the FTC must plead that each of the defendants is violating or is about to violate the law. A permanent injunction is appropriate when the FTC shows that there exists some cognizable danger of recurrent violation, more than the mere possibility that it may happen.

The complaint detailed a years' long effort of Defendants to entice consumers to transfer cryptocurrency assets onto their platform. They failed to maintain sufficient reserves to meet customer obligations, misappropriated consumer funds, and concealed the company's financial trouble from the public while withdrawing their own funds from the platform. Thus, the complaint alleged egregious conduct and serious harm to consumers. Moreover, each individual Defendant continued to deny their roles in the misconduct and maintained the means, ability, and incentive to resume their unlawful conduct.

Violations of the GLB Act. Because the same individual liability standard that applies under Section 5 of the FTC Act applies to an inquiry into individual liability for individual violations of the GLB Act, the court concluded that the FTC had adequately alleged that the individual Defendants had both the "authority to control" and "knowledge or awareness" of the alleged GLB Act violations. The GLB Act makes it unlawful for any person to obtain or attempt to obtain customer information of a financial institution relating to another person by making false, fictitious, or fraudulent representations to a customer of a financial institution.

The complaint adequately alleged that Defendants violated this provision of the law by making false representations about Celsius' financial services offerings, including that Celsius earned profits at no risk to consumers and maintained billions of dollars in liquidity, in order to obtain customers' bank account and cryptocurrency wallet information. Furthermore, contrary to the assertions of Defendants, the FTC has the statutory authority to seek monetary relief for violations of the GLB Act.

The Case is No. 1:23-cv-06009-DLC.

Attorneys: Katherine Worthman for the FTC. Benjamin R. Allee (Yankwitt LLP) for Alexander Mashinsky. William Michael Regan (Hogan Lovells US LLP) for Shlomi Daniel Leon. Avi Weitzman (Paul Hastings LLP) for Hanoch Nuke Goldstein.

Cases: ConsumerProtection StateUnfairTradePractices FederalTradeCommissionNews