Defending Against the New Wave of Crypto Class Actions

Given the proliferation and volatility of cryptocurrencies available on the market today and the multitude of ways you can buy, leverage, short, borrow, and lose all your money - there’s no question that lawsuits are soon to follow.     

Current State of Affairs 

Crypto Class Actions are already in full swing with 11 class actions filed on April 3, 2020  in the Southern District of New York. In this post, I’ll do a high level breakdown of the types of class actions currently in motion and the defences which can be brought. Seeing as blockchain technology moves at breakneck speeds and regulation limps far behind, it’s unclear how these defenses will hold up going forward as regulatory agencies vie for more control over the space. 

Shout out to the team at Murphy and McGonigle for the great webinar they did on this topic earlier in the year. Nothing in this post is legal advice and should not be construed as such. 

Quick Overview of the Lawsuits

Of the 11 Class Actions brought in NY, 7 are against token issuers and 4 against crypto-asset exchanges and their principals (see full list below). The plaintiffs bringing the cases are token investors who either purchased the tokens during an ICO and/or on exchanges. The suits name numerous parties, including exchanges Binance, KuCoin, BiBox, and BitMEX and, and crypto issuers Block.one, Quantstamp, KayDex, Civic, BProtocol, Status, and the Tron Foundation  (see list below for full details). What’s really going to be interesting is that 10 different judges are assigned to 11 different cases so theoretically, they could all have different outcomes. 

What these cases come down to is that token purchasers (the “Plaintiffs”) lost money and are not happy about it. They bought tokens for more than they could sell them for and now want to recoup their losses. Generally, you can’t just get your money back if you chose the wrong investment so the Plaintiff’s need to have a regulatory claim. Therefore, Plaintiffs are filing claims against the Token Issuers (the “Defendants”) for selling unregistered securities which violates various securities laws (more info below). The remedy for a claim of this type is to rescind their purchases (ie. give their money back for tokens purchased) or money damages. 

As for the claims against the Exchanges (also the “Defendants”), there are two allegations: (1) each token is an unregistered security that was traded on the defendants’ unregistered exchanges, OR that the Defendants acted as unregistered brokers or dealers AND (2) Defendants entered into contracts to promote and sell the unregistered tokens on unregistered exchanges or through unregistered brokers or dealers. The remedy is also to rescind or money damages. 

Potential Defenses 

The general view of the SEC & CFTC is that all tokens are securities (except BTC and ETH). So how do you overcome this assumption in Court? Below are the seven best defenses that the Token Issuers and Exchanges can use to win the class actions. Five of those defenses are on merit and three are procedural. I’m not going to go into detail for each and every defense. I started, but my post quickly became far too long. Each defense is nuanced and viewed differently by the various regulatory bodies who claim jurisdiction over blockchain and cryptocurrency so I decided to stick with just a high level overview. I included a chart of each case for those of you that want to read them. 

1. Defenses on the Merit 

   1. Tokens are not securities 

      1. Apply Howie test: an “investment contract” exists when there is (1) an investment of money; (2) in a common enterprise; (3) with a reasonable expectation of profits; (4) to be derived from the efforts of others.

   2. The statutes do not reach extraterritorial conduct 

      1. Generally, US Securities Laws do not apply to securities transactions outside the US but the court will look at secondary market transactions, marketing materials, etc to show US transactions. 

   3.  The defendants are not statutory sellers

      1. A statutory seller is one who successfully solicits the purchase, motivated at least in part by desire to serve his own financial interests or those of the securities owner. 

      2. Statutory Seller liability requires solicitation & motivation. A big question this raises is whether secondary markets rise to solicitation and seller benefit.  

   4. Commodity Exchange Act issues (HDR Action for Market Manipulation)

      1. Possible Defences: 

         1. Due Process/Void for Vagueness

            1. New space & not much guidance in terms of delivery and applicability of virtual currency to CEA rules 

         2. Manipulation 

            1. Extraordinary fact intensive & very hard to prove 

            2. See cases Monex, Kraft, DRW for launching manipulation defense 

         3. Aiding/Abetting - must establish knowledge 

         4. Statue Of Limitations - 2 yrs if claim arose before 2018 

   5. Control person liability issues

2. Procedural Defenses  

   1. Statutes of limitations (SOL)

      1. SOL’s bar claims after a certain period of time passes after an injury

      2. For security claims, SOL runs within 1 yr  from the violation itself (when tokens were issued), not investor knowledge or no later than 3 yrs after the security was bona fide offer to the public

   2. Personal jurisdiction  (PJ)

      1. PJ is the power that a court has to make a decision regarding the party being sued in a case.

      2. Legal standard

         1. Minimum contacts with the state, as shown by purposeful availment

         2. Exercising personal jurisdiction does not offend “traditional notions of fair play and substantial justice”

   3. Forum non conveniens 

      1. a discretionary power that allows courts to dismiss a case where another court, or forum, is much better suited to hear the case)

Key Takeaways

The general consensus of regulating bodies is that all tokens are securities that must adhere to securities laws. Securities laws are antiquated and apply broadly to most cryptocurrencies. These laws also apply cross borders - so if you’re selling to US customers but are based outside of the US, you must adhere to US Securities laws (hence the CTFC/BitMex case that was just filed this week). It’s crucial for defendants to distinguish between their token and previous ICOs suits to show why the facts do or do not apply based on past case law.

Again, none of the above is legal advice but I thought it was interesting to see a breakdown of what’s going on in the courts. I’ll be keeping tabs on how these cases play out over the next few years as they have considerable power to shape how the US handles crypto cases.

Chart by Murphy & McGonigle, P.C.