Key Takeaways

• The Department of Justice (DOJ) brought an action against Avraham Eisenberg for alleged commodities fraud, commodities market manipulation and wire fraud for fraudulently obtaining approximately $110 million in cryptocurrency by artificially manipulating the price of perpetual futures contracts (Perpetuals) on the Mango Markets decentralized exchange.
• The Commodity Futures Trading Commission (CFTC) brought an action against Eisenberg for conducting an allegedly fraudulent and manipulative scheme to manipulate the price of the “MNGO” token, manipulate the price of MNGO-USDC swaps, and use the artificially inflated value of his MNGO-USDC swaps to obtain digital asset commodities (bitcoin, ether and Tether) from a decentralized exchange by “oracle manipulation,” treating USDC, Tether and MNGO-USDC swaps as commodities.
• The Securities and Exchange Commission (SEC) brought an action against Eisenberg for alleged securities fraud and market manipulation of the market of MNGO tokens, which the SEC alleges is a security, and indicated the investigation is still ongoing, so additional claims may be brought.
• The CFTC announced that this is its first enforcement action for a fraudulent or manipulative scheme involving trading on a decentralized digital asset platform and its first involving an oracle manipulation scheme.
• The Eisenberg case signals to those engaging with derivatives involving stablecoins and other digital assets that they may be subject to both CFTC and SEC regulations simultaneously.

Background

Mango Markets is a decentralized cryptocurrency exchange that allows users to purchase and borrow cryptocurrencies and cryptocurrency-related financial products.[1] Mango Markets is run by the Mango Decentralized Autonomous Organization (Mango DAO), which has its own crypto token named MNGO. Holders of MNGO tokens can vote on changes to Mango Markets and other issues related to the governance of the Mango DAO.[2]

Mango Markets users are able to buy and sell Perpetuals, which allows them to buy or sell exposure to future movements in the value of one cryptocurrency relative to another.[3] Pricing of the Perpetuals is set by an “oracle,” which refers to a computer program that calculates the relative value of cryptocurrencies by comparing the exchange rates across various cryptocurrency exchanges.[4] Whenever the oracle price changes for a particular pairing of cryptocurrencies, the price of the Perpetual is reflected on Mango Markets.[5]

Using accounts he anonymously opened on Mango Markets, each initially funded with USDC,[6] Eisenberg sold and contemporaneously bought Perpetuals.[7] On one account, Eisenberg held a “long” position, the value of which would rise when the value of the MNGO token rose above a certain threshold relative to the USDC.[8] On another account, he held a “short” position, the value of which would rise if the value of the MNGO token fell below a certain threshold relative to the USDC.[9] By making a series of large purchases of MNGO across multiple external cryptocurrency exchanges upon which the Mango Markets oracle relied to calculate the price of MNGO (“oracle manipulation”), Eisenberg was able to create the false appearance of MNGO demand to artificially increase the price of the MNGO tokens on Mango Markets relative to the USDC. That relative price was reflected in the artificially inflated price of the Perpetuals on Mango Markets.

Eisenberg ultimately cashed out his profits based on the inflated value of his collateral, “borrowing” and then quickly withdrawing over $110 million worth of digital assets from Mango Markets — nearly all of the assets available on the platform.[10] Eisenberg then contacted Mango Markets and offered to return a portion of the assets if Mango Markets agreed to, inter alia, not pursue criminal charges.[11] He ultimately returned approximately $67 million worth of digital assets to Mango Markets.[12] Two days after the Mango DAO accepted Eisenberg’s proposal to return the funds, Eisenberg tweeted: “I was involved with a team that operated a highly profitable trading strategy.”[13]

The DOJ, CFTC and SEC each brought separate actions related to these events.

DOJ Action

On Dec. 23, 2022, the DOJ filed a complaint in the Southern District of New York, charging Eisenberg with commodities fraud, commodities manipulation and wire fraud. A grand jury returned an indictment with the same charges on Jan. 9, 2023. According to the indictment, Eisenberg “deceptively used two accounts on Mango Markets that did not appear to the public to both be controlled by him [to make] a series of large purchases of MNGO using USDC, with the objective of artificially increasing the price of MNGO relative to USDC,” which had the effect of increasing the Perpetuals by approximately 1300%.[14] The grand jury further found that the artificial increase in the value of the Perpetuals allowed Eisenberg to borrow and then withdraw millions of dollars’ worth of various cryptocurrencies from Mango Markets, which he had no intention of repaying.[15] Notably, the DOJ relied on broad wire fraud provisions and the Commodity Exchange Act (CEA) as the basis for its allegations and specifically alleged that “virtual currencies, such as USDC, are ‘commodities’ under the Commodity Exchange Act.” The DOJ made no comment on the classification of MNGO, but Assistant Attorney General Kenneth A. Polite Jr. of the DOJ’s Criminal Division signaled the agency’s focus on prosecuting crimes involving digital assets, stating that “[e]xploiting decentralized finance platforms is the new frontier of old school financial crimes in which criminals abuse emerging technologies for their own personal gain.”[16]

CFTC Action

On Jan. 9, 2023, the CFTC brought its own enforcement action against Eisenberg in the agency’s first enforcement action for a fraudulent or manipulative scheme involving trading on a decentralized digital asset platform. In its complaint, the CFTC alleges that Eisenberg’s “manipulative and deceptive scheme” artificially inflated the price of derivative contracts (referred to as “Perpetuals” above) made available on the platform, thereby violating the CEA and “culminating in the misappropriation of over $100 million from the platform.”[17]

The CFTC charges Eisenberg with violating Section 6(c)(1) of the CEA[18] and Regulation 180.1(a)[19] for manipulative or fraudulent conduct, as well as CEA Sections 9(a)(2)[20] and 6(c)(3)[21] and Regulation 180.2[22] for price manipulation of a swap. Specifically, in its complaint, the CFTC alleges that the MNGO-USDC swaps meet the definition of “swaps” under 7 U.S.C. § 1a(47) and 17 C.F.R. § 1.3 and are thus subject to the prohibitions of the CEA.[23] By engaging in a “scheme to manipulate the price of MNGO, manipulate the price of MNGO-USDC Swaps, and use the artificially inflated value of [the] MNGO-USDC Swaps as collateral to withdraw ... digital asset commodities,” Eisenberg is alleged to have “directly or indirectly used or employed ... a manipulative device, scheme, or artifice to defraud.”[24] The CFTC additionally alleges that by his conduct, Eisenberg manipulated, or attempted to manipulate, the price of the MNGO-USDC Swaps in violation of the CEA. While the CFTC does not directly state that the MNGO token is a commodity, by referring to the MNGO-USDC Swaps as swaps (as opposed to mixed swaps, security-based swaps, etc.) and exerting jurisdiction over the MNGO spot market, the CFTC is treating USDC, and ostensibly MNGO, as commodities.

The CFTC’s Acting Director of Enforcement, Gretchen Lowe, affirmed the agency’s commitment to “use all available enforcement tools to aggressively pursue fraud and manipulation regardless of the technology that is utilized.”[25]

SEC Action

On Jan. 20, 2023, the SEC brought its enforcement action against Eisenberg. Resting on its conclusion that MNGO is a security (specifically, an investment contract) under federal securities law, the SEC alleged that Eisenberg violated Exchange Act Section 10(b), Rules 10b-5(a) and (c), and Exchange Act Section 9(a)(2), which prohibit fraud and market manipulation of securities.[26]

In reaching its conclusion, the SEC relied on the test articulated in the Supreme Court case SEC v. W.J. Howey Co. (referred to as the Howey test), in which the Court found that an investment contract exists where the following prongs are satisfied: the purchaser (1) invested money (2) in a common enterprise (3) with a reasonable expectation of profits to be derived from the managerial or entrepreneurial efforts of others.[27] The SEC determined that Mango Markets users’ purchase of MNGO with USDC was an investment of money, thereby satisfying the first Howey prong. The SEC averred that there is a common enterprise and that the second prong was satisfied because (1) the price of the tokens moved together “so that each investor profited or suffered losses pro rata based on the ownership share of MNGO tokens,” and (2) Mango Markets “touted that the proceeds of the MNGO token sales would be pooled and used indiscriminately to pursue MNGO’s projects” rather than “divided into subaccounts for sub groups of MNGO token investors.”[28] The complaint also indicates the SEC’s position that the issuance of 5% of the total MNGO token supply to Mango Markets’ 10 creators supports its allegation that the scheme was a common enterprise.

As to the third prong of Howey, the SEC noted that investors could use the MNGO tokens “to participate in liquidity provider pools on the Mango Markets platforms” in order to “earn more MNGO tokens as a reward for providing liquidity” and “continuously earn interest on their tokens”[29] and, therefore, had an expectation of profits. In addition, the creators provided “significant managerial efforts to develop the platform, both prior to and following the MNGO token sale” by developing and deploying the code used to operate the platform; created content for the Mango Markets website and social media channels; submitted and voted on governance proposals related to how the platform operated; and responded to platform inquiries from MNGO token holders.[30] The complaint further alleged that the Mango Markets creators exercised outsized influence over governance proposals based on their token allocations and the abysmal rate of voting participation by non-creator token holders.[31] These facts, the SEC asserts, support a finding that token holders were reliant on the platform’s and token’s creators to make the token a success.

Echoing statements made by DOJ and CFTC staff, David Hirsch, Chief of the SEC Crypto Assets and Cyber Unit, commented that “the SEC remains committed to rooting out market manipulation, regardless of the type of security involved.”[32]

Latest Updates

On Jan. 25, 2023, Mango Labs LLC also brought suit against Eisenberg, alleging conversion, fraud, misrepresentation and unjust enrichment. The plaintiff, an organization that conducts research and development for Mango Markets, is seeking punitive and exemplary damages as well as declaratory judgment on the invalidity of the settlement and release agreement.

With regard to the criminal charges brought by the DOJ, on Feb. 2, 2023, Eisenberg was ordered held without bail by the New York federal judge presiding over the case.

Conclusion

These cases highlight the jurisdictional overlap asserted by regulatory agencies in the crypto asset industry. While it is not uncommon for the DOJ and a regulatory agency to bring parallel criminal and civil actions for the same conduct or different elements of a scheme, the SEC and CFTC both bringing actions for the same conduct and treating the same asset (MNGO tokens) as both a security and a commodity are not common. While the SEC asserts that MNGO is a security, the CFTC effectively asserts it is a commodity by alleging the MNGO-USDC Swap meets the definition of a “swap” under the CEA.[33] Notably, the CFTC also asserts that stablecoins are commodities as well.

These cases also inform crypto asset issuers and crypto market participants that crypto asset exchange activity may be regulated by both the CFTC and the SEC for the same activity and/or different aspects of the activity. As such, cryptocurrency exchanges, lenders and businesses planning to create or otherwise integrate cryptocurrency tokens into their business models would be well advised to engage with competent legal counsel to ensure that they are operating within the confines of the applicable commodities and securities laws, regulations and best practices.

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