FTC moved quietly against Butterfly Labs to avoid tipping off bitcoin operation

Federal court orders to seize control of Butterfly Labs Inc. came without notice to the bitcoin business, a spokesman for the company complained Wednesday.

Charles Zinkowski said officials for the Overland Park-based firm had no contact with the Federal Trade Commission before the company’s assets were frozen and control given to a court-appointed receiver.

The federal agency said it moved quietly to avoid tipping off its target and to preserve corporate funds that it charged were being misspent at department stores and on massages.

Butterfly Labs officials were not available to comment on the charges of misspent funds.

The FTC sought the court orders as part of its lawsuit against BF Labs Inc., which does business as Butterfly Labs, and Sonny Vleisides, Darla Drake and Nasser Ghoseiri, who are connected to it. The lawsuit charged that the company took $20 million to $50 million from more than 20,000 consumers in a bogus bitcoin computer scheme.

In a statement issued Tuesday, Butterfly Labs had questioned why the FTC “wouldn’t simply let this case play out through the judicial system” rather than pursue a takeover by the receiver.

The FTC said its move against the company was sparked by thousands of consumer complaints and its own investigation. It seeks to return funds to consumers.

It sought and won a temporary restraining order under seal in U.S. District Court in Kansas City, keeping the actions out of the public eye until its agents and the receiver could carry out a court-approved inspection at Butterfly Labs.

“We went to court without notifying the other party … because we were concerned about a dissipation of assets,” said Malini Mithal, assistant director of the FTC’s division of financial practices. “We were worried about seeing corporate funds go to Nordstrom, Bed Bath & Beyond, gun stores and things like that.”

On Tuesday, Butterfly Labs complained in a statement that the federal agency was “heavy-handed” and had “acted as judge, jury and executioner ” in seizing control.

The company also complained that the FTC has portrayed it as “bogus and fake” though it has shipped more than $33 million in products to customers and granted $17 million in refunds.

Butterfly Labs sold computers that it said would generate the virtual currency for buyers. The FTC complaint said the company failed to deliver most of them, delivered defective machines or delayed delivery so long that the equipment was obsolete.

Bitcoins are an alternative form of money not sponsored by any government and earned by completing complex calculations that require increasingly sophisticated computers to handle. They are accepted by some individuals and businesses as currency.

The FTC provided a copy of an originally sealed document that outlined the spending it said was cause for concern.

It said Butterfly Labs’ funds had been spent at stores “including Nordstrom, Bed, Bath, & Beyond, Restoration Hardware, and Hobby Lobby” as well as for “massages, auto maintenance, day care services, gun stores, hunting stores and sporting event tickets.”

It also noted that the company quickly moved money out of corporate bank accounts once it was received from customers, keeping no more than $2 million in the business accounts at any time.

The FTC also cited a federal mail fraud conviction for which Vleisides, Butterfly Labs’ principal stockholder, was on probation. The court should freeze assets because Vleisides had failed to provide his probation officer accurate information about his own finances, the document said.

“The record shows that once defendants take possession of consumer funds, they quickly exit company accounts, and that defendants, in many instances, have diverted them to personal use,” the document said.

Attorneys for both sides will battle in federal court Monday morning when the temporary order granted to the FTC is set to expire. U.S. District Judge Brian C. Wimes set the hearing to allow Butterfly Labs an opportunity to show why he should not replace the temporary order with a more lasting preliminary injunction.

Butterfly Labs said it has dozens of employees. The address it lists is in Overland Park though the company’s website and Zinkowski said the company was in Leawood.

This story was originally published September 24, 2014 at 7:49 PM with the headline "FTC moved quietly against Butterfly Labs to avoid tipping off bitcoin operation."