Block.one ruling illustrates complications for crypto investors

A federal judge’s recent refusal to approve Block.one’s $27.5 million settlement with investors highlights challenges facing cryptocurrency investors trying to recover their money in class-action lawsuits against companies based outside the United States.

Block.one, a blockchain technology developer based in the Cayman Islands, agreed to the settlement to end a lawsuit filed by the Crypto Assets Opportunity Fund related to a token sale of the firm several years ago.

United States District Judge Lewis Kaplan of the Southern District of New York refused to give final approval to the proposed settlement on August 15. The ruling grappled with how to determine when a blockchain transaction takes place in the United States—and is covered by U.S. securities laws—and when it takes place abroad.

The case illustrates “the difficulty of trying to determine whether you have a U.S. transaction,” said Proskauer Rose LLP attorney Jonathan Richman. The ruling also underscores the challenges of dealing with these issues on a class basis.

Kaplan said he was not convinced that Crypto Assets, which bought tokens in both foreign and US transactions, could represent the interests of investors whose transactions mainly took place in the US.

“You have to deal with the differences between the class members in terms of whether they do or don’t have transactions that are subject to US securities laws,” Richman said.

Investor class action lawsuits related to cryptocurrency are on track to reach a record high in 2022, according to a recent report from Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse. Ten class actions were filed in the first half of 2022, compared to 11 during the whole of last year.

Domestic transactions

A Supreme Court ruling from 2010, Morrison v. National Australia Bank, limited the reach of US securities law to securities listed on domestic exchanges and to “domestic transactions” in other securities.

Various circuit courts, including the U.S. Court of Appeals for the Second Circuit, agree that a transaction is domestic if “irrevocable liability” shifted from the seller to the investor in the United States. However, the courts are struggling with what “irrevocable liability” means in the context of a blockchain transaction.

“The more complex an international transaction is, it’s often very difficult to tell where it is,” said Norton Rose Fulbright US LLP attorney Robert Schwinger.

With blockchain, “when the thing passes through many, many nodes of computers all over the world, it’s much more complicated than your traditional securities scenario,” Schwinger said. A node refers to a computer connected to the cryptocurrency network.

In a case involving the Tezos blockchain project, a California district judge said a transaction became irrevocable “after it was validated by a network of global ‘nodes’ clustered more closely in the United States than in any other country.”

A New York judge, in a case brought by investors who bought the HelbizCoin cryptocurrency, focused on the buyer’s location at the time of the transaction. In Utah, a district court found that transactions in securities sold over the Internet occur with both the seller and the buyer.

“There are at least nuanced differences in existing case law about trying to determine how irrevocable liability is incurred between buyer and seller in a blockchain transaction,” Richman said. – This is certainly in development.

Kaplan appeared to question some of the existing approaches in the case against Block.one.

Without deciding which test is correct, Kaplan suggested what matters might be the location of the first node to confirm the transaction, as that is what makes the transaction binding. Such a test “seems to be manageable” and follows precedent, he said.

Questions about what is the right approach is something that is expected to continue to be litigated.

“I see this coming up more often as we have an increasing number of private claims being made,” said University of Arkansas law professor Carol Rose Goforth.

One advantage of a first-node test is that it’s simple, said Samuel Dibble, a lawyer at Baker Botts LLP, although it’s not clear it can fit all blockchain transactions. The simplicity of the test has the potential to create problems.

“People will try to escape the jurisdiction of the United States by routing their traffic outside for the first node verification,” said Indiana University law professor Sarah Hughes.

Complicated matters

Investors sued Block.one in 2020, alleging the firm defrauded them “through a year-long illegal coin offering.” Block.one agreed to pay $24 million the previous year to settle allegations by the Securities and Exchange Commission that it sold unregistered securities.

Block.one has maintained the investors’ case is “without merit” and “filled with many inaccuracies.”

An inability of crypto investors to link transactions to the United States could be a reason for the courts to dismiss a lawsuit. Block.one’s case highlights how the issue can raise issues at other stages of litigation – and get in the way of a settlement.

Kaplan worried Crypto Assets may have an incentive to accept a lower settlement offer than would have been required by investors who primarily engaged in US transactions. He noted that the deal was 75% less than the total claimed loss “mainly due to the presence of foreign purchases.”

The judge said he was “not implying any misconduct or criticism of the lead claimant or its experienced and reputable lead counsel”. Rather, this was “a structural problem rooted in the unusual market at issue.”

There can be solutions to this type of problem, say lawyers. On Monday, a person who said almost all of his token purchases were domestic asked to be replaced as the lead plaintiff in the lawsuit.

Still, Kaplan’s ruling is “definitely a warning that [these cases] are complicated,” Richman said.