Crypto Lawsuits, Defense Industry Should Watch | Bilzin Sumberg

Cryptocurrency companies are facing an ever-increasing number of lawsuits, adding to a list of recent headaches for their industry. This list includes steep recent drops in investment value and a high likelihood of new government regulations in the near future.

Investor losses have prompted a wave of new class-action and other lawsuits against issuers, platforms, managers and even celebrity promoters.[1]

Many of the suits allege pump-and-dump schemes, where company officials essentially artificially inflate the company’s market value, then cash out and leave investors holding the bag while prices plummet.

Others claim that cryptocurrency issuers misled investors in other ways, such as through deceptive marketing. Still others involve allegations that the company’s digital tokens are unregistered securities and violate Title 15 of the US Code, Section 77e(c) – part of the Securities Act.

Many cases targeting crypto companies, or individuals associated with them, have either been dismissed on procedural grounds, voluntarily dismissed by the plaintiffs, or settled privately. As a consequence, it is extremely difficult to assess the likelihood of success for pending or future claims of this type.

What is clear, however, is that all of these categories of claims, and others, are ones to which the crypto industry has significant potential vulnerability. Here is a more detailed overview of the types of claims and arguments most often made by plaintiffs so far, and the counterarguments from crypto companies and their executives and promoters.

Violation of the Securities Act

Several lawsuits allege that crypto companies issue and sell unregistered securities in violation of the Securities Act. A crypto asset is likely to be considered a security if it satisfies the four-pronged Howey test. This test, named after the highly influential 1946 US Supreme Court case US Securities and Exchange Commission v. WJ Howey Co., requires that:

1. A party must make an investment of money or other valuable consideration;

2. The investment must be in a “joint enterprise”;

3. Investors must have a “reasonable expectation of profit”; and

4. The profit is expected to be “derived from the efforts of others”.

Some federal courts have ruled that, under certain circumstances, cryptocurrencies may be subject to federal securities laws.[2] In response to these allegations, defendant crypto platforms, such as Coinbase Global Inc., have argued that while crypto is a value — as opposed to a commodity or anything else — it is not bought or sold by the platform, but rather the platform is the intermediary that matches users and earn fees from user transactions.

Another crypto platform, Binance Holdings Ltd., successfully argued that because it was a foreign entity, federal securities laws were inapplicable to it.

One case that highlights the complex and fact-intensive nature of cryptocurrency classification is the class action Audet v. Fraser in the US District Court for the District of Connecticut. The jury in that case concluded in November 2021 that none of the crypto products purchased by the class were securities under the Howey test.

But after considering the plaintiff’s post-verdict motions, the court on June 3 rejected the jury’s finding that one product, Paycoin, was not an investment contract and ordered a new trial to determine the classification of Paycoin.

In addition to private lawsuits, crypto companies are currently facing lawsuits filed by regulatory agencies, such as the SEC, for failure to register securities in violation of securities laws.

One such case is SEC v. Ripple Labs Inc. in the US District Court for the Southern District of New York, which could have huge implications for the crypto industry because, if Ripple loses, many tokens traded on platforms in the US will be required. to register with the SEC.

So far, the judge hearing that case has denied Ripple’s motion to dismiss, but has also denied the SEC’s request to strike Ripple’s affirmative defense that it was never given fair notice by the agency that the token sale violated securities laws.

Fraud

Many lawsuits involving the crypto industry involve allegations of fraud, misrepresentation, and/or that the crypto companies, or individuals associated with them, engaged in pump-and-dump schemes.

For example, in In Re: EthereumMax Investor Litigation, investors have accused celebrities like Kim Kardashian and Floyd Mayweather of promoting on social media what many have alleged was a classic pump-and-dump scam.

The plaintiffs allege that the defendants knowingly and improperly – through allegedly misleading, inaccurate statements – inflated the price of the token, then sold their holdings and let other investors suffer the losses when the value of the token depreciated by over 70% from its total value. holiday.

In De Ford v. Koutoulas, the US District Court for the Middle District of Florida recently dismissed without prejudice a putative class action brought by buyers of “Let’s Go Brandon” meme tokens who sued LGBcoin and NASCAR driver Brandon Brown for fraud. Like the EthereumMax case, investors in the “Let’s Go Brandon” token alleged that the crypto company and celebrity driver knowingly engaged in a scheme to launch a cryptocurrency that would reach an inflated value and then crash when the true facts about it came to light .

The matter was dismissed July 11 as a shotgun action, which is essentially a complaint too vague to give defendants fair notice of the claims being pursued. Given that the dismissal was without prejudice, the plaintiffs now have an opportunity to attempt to resume their claims.

Plaintiffs in the US District Court for the Central District of California’s securities fraud case Merkamerica Inc. v. Glover, on the other hand, were deemed to have satisfactorily defended their claims. In that case, investors who bought Kowala’s token, kCoin — a crypto token that the defendants had never actually considered mining — based on misrepresentations by Kowala’s executives, have filed a securities fraud lawsuit against those executives.

The court ruled in December 2019 that the plaintiffs had alleged their fraud claim with enough specificity to survive the motion to dismiss.

Going forward, a key question in all of these Fraud and Securities Act lawsuits filed as putative class actions will be whether the courts actually certify the cases as class actions.

So far, there has only been one class certified by a court in a cryptocurrency class action: Williams v. KuCoin. The Southern District of New York in February certified the class as all buyers who bought or sold the same token as the named plaintiff, as opposed to the customers for KuCoin’s full portfolio of tokens. The court certified the class even though its size, with only 26 members, fell into a gray area for the numerical requirement for class actions.

Central to the court’s approval was that the plaintiffs would be better off proceeding as a class, rather than as individuals, given the relatively modest amount in controversy for each individual and that “the issues common to the class predominate over individualized ones because most all elements of plaintiffs and each proposed class member’s claims present issues amenable to class-wide resolution.”

The plaintiffs voluntarily dismissed the case in June before the court made any decision on the merits.

Conclusion

While we await further developments on the critical issue of class certification, there are other elements that crypto companies, and the investors looking at them, may want to note and consider.

To reduce the likelihood of a fraudulent or false claim, crypto companies and those associated with them should be careful to be factual and not exaggerated when claiming the perceived values ​​of a coin or platform. Furthermore, crypto companies and investors should track recently filed lawsuits for any major updates, including the SEC lawsuits, and stay up to date on any new SEC regulations.

[1] Regarding celebrity promoters, see e.g. Re: EthereumMax Investor Litigation, Docket No. 2:22-cv00163 (CD Cal., Jan. 7, 2022).

[2] See US v. Zaslavskiy, 2018 WL 4346339 (EDNY Sept. 11, 2018). The court ruled that prosecutors could proceed with their criminal securities case against Zaslavskiy, who admitted defrauding investors in initial coin offerings (ICOs) for two cryptocurrencies that he claimed were backed by real estate and diamonds. The judge ruled that an ICO qualified as an “investment contract” under the Howey test.

*This was republished with permission from Law360. Click here to access the publication.