alerts & publications
Discovering a Discovery Rule in Crypto Cases? The Uphill Struggle Plaintiffs Face in Trying to Resurrect Time-Barred ICO Claims4月 14, 2020
In nearly a dozen early-April cryptocurrency-related actions filed in the Southern District of New York, plaintiffs advance an untested theory that they hope will allow them to pursue otherwise time-barred claims: that SEC guidance issued last year effectively extends the statute of limitations for their claims. While plaintiffs’ theory faces substantial hurdles, it threatens to open the door to other plaintiffs making similar claims to extend the applicable statutes of limitations against other digital asset projects and trading platforms.
On April 3, a handful of named plaintiffs, all represented by the same two law firms, filed 11 securities class actions targeting four crypto-asset trading platforms and seven digital-asset sellers. The suits allege that defendants violated federal and state securities laws by failing to register the offer and sale of digital assets or to register as exchanges or broker dealers with the SEC. Plaintiffs claim that digital assets are, in fact, securities, despite contrary statements made by defendants. Each action rests on different alleged facts, but they all share a common federal claim: that the crypto companies and exchanges violated Sections 5 and 12(a)(1) of the Securities Act of 1933 by offering and selling unregistered securities (Section 12(a)(1) claims).1
Digital asset sellers and trading platforms have faced Section 12(a)(1) claims before.2 What’s new here is that plaintiffs seek to hold defendants liable for initial coin offerings, or “ICOs,” dating back to 2017, even though Section 12(a)(1) claims are subject to a one-year statute of limitations. 15 U.S.C.S. § 77m. Plaintiffs offer a creative, though untested, argument to seek to get around that statute: that they could not have discovered their claims until April 3, 2019, when the SEC issued a Framework for “Investment Contract” Analysis of Digital Assets (the “SEC Framework”).3 Plaintiffs claim that the SEC Framework alerted them that the digital assets they had purchased might be securities.4
While statutes of limitations can, in certain narrow circumstances, be tolled until a plaintiff discovers an injury, plaintiffs’ argument that this “discovery rule” applies here is likely to fail for at least three reasons. First, courts have already found that the discovery rule does not apply to Section 12(a)(1) claims.5 Second, the discovery rule applies only where a plaintiff was prevented from discovering the facts underlying the claim—here, plaintiffs rely simply on regulatory guidance, not on any facts about the digital asset, sellers, or trading platforms. Likewise, courts have found that a one-year statute of limitations applies to claims under Sections 5, 15(a), and 29(b) of the Securities Exchange Act of 1934 (Section 29(b) claims), which plaintiffs have raised against crypto-trading platforms for operating as unregistered exchanges or broker dealers, and that the statute of limitations should not be tolled even by the discovery of new legal rights—which the SEC Framework is not.6 Third, plaintiffs will struggle to argue that the SEC Framework constitutes new law, as it is only non-binding staff regulatory guidance.
The Discovery Rule Does Not Apply To Section 12(a)(1) Claims.
Section 12(a)(1) provides a private right of action for the sale of unregistered securities. Under Section 13 of the Securities Act, a plaintiff must bring a Section 12(a)(1) claim “within one year after the violation upon which it is based.” 15 U.S.C.S. § 77m (emphasis added). There is no “discovery” component in the statutory language. In contrast, the Section 13 provision governing Sections 11 and 12(a)(2) claims for material misstatements or omissions in the registration statement and prospectus, respectively, is expressly tied to discovery: “within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence[.]” Id. The stark contrast in the plain language of these distinct statutes of limitation makes clear that Congress intended for the discovery rule to apply only to Sections 11 or 12(a)(2) claims, not to Section 12(a)(1) claims.
The Supreme Court recently refused to “read in” a discovery rule when faced with similar language in a different statute. See Rotkiske v. Klemm, 140 S. Ct. 355, 360 (2019) (citation omitted) (“This expansive approach to the discovery rule is a bad wine of recent vintage.”). There, the Supreme Court declined to read a general discovery rule into the plain language of the Fair Debt Collection Practices Act (FDCPA), noting that “atextual judicial supplementation is particularly inappropriate when . . . Congress has shown it knows how to adopt the omitted language or provision.” Id. at 361. And, unlike the FDCPA—or Section 12(a)(1)—Congress has enacted statutes that expressly provide for the limitations period to run from the date a violation is or should have been discovered. Id.
Not surprisingly, therefore, almost every circuit that has considered this question has declined to apply the discovery rule to Section 12(a)(1) claims.7 This includes courts considering Section 12(a)(1) claims in the context of ICOs.8
Plaintiffs may attempt to rely on Katz v. Amos, 411 F.2d 1046, 1055 (2d Cir. 1969), a half-century-old Second Circuit opinion that applied the discovery rule to a Section 12(a)(1) claim. See also Mori v. Saito, 2012 WL 13042573, at *8 (S.D.N.Y. Feb. 16, 2012) (“a cause of action under section 12(1) accrues only when a plaintiff discovers, or should reasonably have discovered, the alleged violation.”). Although Rotkiske suggests that Katz may no longer be good law, it is easily distinguishable in any event. In Katz, the key factor in the court applying the discovery rule was that the plaintiffs were fraudulently induced to invest by false claims that the securities would imminently be registered with the SEC and defendants’ fraudulent concealment. Katz, 411 F.2d at 1055. In the recently filed cases, in contrast, defendants are not alleged to have concealed any facts. To the contrary, the digital asset sellers and trading platforms never said that they were registering the offer and sale of digital assets as securities, nor did they conceal that the tokens were unregistered.
The Discovery Rule Requires New Facts, Not New Regulatory Guidance.
Even if plaintiffs could overcome the absence in Section 13 of a discovery rule for Section 12(a)(1) claims, they still would have to come forward with facts, as opposed to legal guidance, that could not have been discovered without reasonable diligence. The discovery rule traces its origins to fraud cases in the 1700s, when courts recognized that “a defendant’s deceptive conduct may prevent a plaintiff from even knowing that he or she has been defrauded.” Gabelli v. S.E.C., 568 U.S. 442, 449 (2013) (citation omitted). Because of its focus on what defendants concealed from prospective plaintiffs, courts generally have applied the discovery rule only in cases where a defendant’s fraud prevented a plaintiff from discovering the facts that form the basis for the plaintiff’s claim.9 Even in Katz, for example, the Second Circuit noted that the statute of limitations was only tolled so long as the plaintiff was prevented from discovering the fact that a proposed public offering was no longer being considered. 411 F.2d at 1055. But courts generally have refused to apply the discovery rule where, as here, a plaintiff claims ignorance of his legal rights.10 Here, while the SEC Framework may have alerted the plaintiffs to existing legal positions, it did not reveal any facts.
The same analysis applies to plaintiffs’ Section 29(b) claims for operating as an unregistered exchange or broker dealer. Courts have found that the one-year statute of limitations for Section 29(b) claims runs from “the time when an individual could have, through the exercise of reasonable diligence, discovered the fraud at issue.” Alpha Capital Anstalt v. Oxysure Sys., Inc., 216 F. Supp. 3d 403, 408 (S.D.N.Y. 2016) (citation omitted); see also Weiss v. Altholtz, No. 10 C 02609, 2011 WL 4538459, at *2–3 (N.D. Ill. Sept. 29, 2011). “Ignorance of the law alone does not toll statutes of limitations.” Alpha, 216 F. Supp. 3d at 408. Rather, the plaintiffs’ Section 29(b) claims accrued when they purchased the digital assets, which is when they knew or could have easily discovered that the trading platforms were not registered with the SEC. Id.; Weiss, 2011 WL 4538459, at *2; Celsion Corp. v. Stearns Mgmt. Corp., 157 F. Supp. 2d 942, 948 (N.D. Ill. 2001) (“it is the discovery of the facts constituting the violation that starts the one-year period of limitations . . . .”) (citation omitted).
The SEC Framework Is Not New Law.
Finally, even if plaintiffs were somehow to persuade a court that the discovery rule applies both to Section 12(a)(1) claims and to discovery of their legal rights, they would still run headlong into the reality that the SEC Framework is not actually new law. Rather, it represents non-binding views of the SEC staff on applying the decades-old Howey test to digital assets.11 The SEC Framework itself states that it “is not a rule, regulation, or statement of the” SEC, “does not modify or replace any existing applicable laws, regulations, or rules,” and “does not replace or supersede existing case law, legal requirements, or statements or guidance from” the SEC of SEC staff.12 For the same reason, the SEC Framework should have no bearing on the statute of limitations for the Section 29(b) claims, which accrued when plaintiffs could have reasonably discovered that the trading platforms were not registered with the SEC. Alpha, 216 F. Supp. 3d at 408; Celsion, 157 F. Supp. 2d at 948.
The Bottom Line.
In making these strained tolling arguments, plaintiffs seek to open the door to a flood of new crypto litigation. But they should not be able to rely on a non-existent discovery rule to resuscitate stale Sections 12(a)(1) and 29(b) claims against digital asset sellers and trading platforms. Getting as many of these claims as possible dismissed as time-barred will be a crucial early win for digital asset innovators seeking to enable transformative applications of blockchain technology without the burden of protracted litigation.
1 These cases also raise claims under various state laws, which are not addressed here and will require an analysis of the laws of the respective states.
2 See, e.g., Zakinov v. Ripple Labs, Inc., 2020 WL 922815 (N.D. Cal. Feb. 26, 2020) (alleging Section 12(a)(1) violation against Ripple Labs, Inc.); In re Tezos Secs. Litig., 2018 WL 4293341 (N.D. Cal. Aug. 7, 2018) (alleging Section 12(a)(1) violation against, among others, Bitcoin Suisse). Notably, in the recent decision in Zakinov, the Northern District of California addressed the related, but separate, issue of whether plaintiffs’ claims were barred by Section 12(a)(1)’s statute of repose. 2020 WL 922815 at *5–10 (N.D. Cal. Feb. 26, 2020). That case did not address Section 12(a)(1)’s statute of limitations, which is at issue in these cases.
3 Framework for “Investment Contract” Analysis of Digital Assets, SEC (April 3, 2019), available at https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets#_ednref1.
4 The SEC Framework sought to clarify whether and in what circumstances the Commission believes the Supreme Court’s decision in SEC v. W.J. Howey Co. (“Howey”)—which fashioned a test for determining whether investment opportunities are “investment contracts” subject to the federal securities laws—applies to digital assets. 328 U.S. 293 (1946).
5 See, e.g., Cook v. Avien, Inc., 573 F.2d 685 (1st Cir. 1978); Pell v. Weinstein, 759 F. Supp. 1107, 1111 (M.D. Pa. 1991), aff’d, 961 F.2d 1568 (3d Cir. 1992); Nolfi v. Ohio Kentucky Oil Corp., 675 F.3d 538, 553 (6th Cir. 2012); Beranger v. Harris, 2019 WL 5485128, at *5 (N.D. Ga. Apr. 24, 2019); Fabian v. LeMahieu, 2019 WL 4918431, at *8 (N.D. Cal. Oct. 4, 2019).
6 See Alpha Capital Anstalt v. Oxysure Sys., Inc., 216 F. Supp. 3d 403 (S.D.N.Y. 2016); Weiss v. Altholtz, No. 10 C 02609, 2011 WL 4538459 (N.D. Ill. Sept. 29, 2011).
7 See, e.g., Cook, 573 F.2d 685 (holding for Section 12(a)(1) claims that “under the explicit language of § 13, the limitations period runs from the date of the violation irrespective of whether the plaintiff knew of the violation”); Pell, 759 F. Supp. at 1111 (“neither the discovery rule nor equitable tolling are applicable to the one-year limitation period governing nonregistration claims because the language of the statute militates against such an application, and there is little justification for the application of this rule outside fraud-based causes of action.”); Nolfi, 675 F.3d at 553 (“Because the statute permits claims under § 12(a)(2) to proceed if brought within one year of discovery of the violation but does not have a similar discovery rule for § 12(a)(1) claims, Congress’s intent on this matter is clear and that the express language of the statute should be applied.”)
8 Beranger, 2019 WL 5485128, at *5 (citations omitted) (holding in ICO case that “the discovery rule does not apply to the statute of limitations period for Section 12(a)(1) claims” and thus “the clock on the limitations period begins on the date the unlawful sale occurred.”); see also Fabian, 2019 WL 4918431, at *8 (declining in ICO case to apply discovery rule to Section 12(a)(1) claims).
9 See, e.g., Rotella v. Wood, 528 U.S. 549, 556 (2000) (under the discovery rule, a claim accrues when a plaintiff comes into possession of the “critical facts that he has been hurt and who inflicted the injury”); Singleton v. Clash, 951 F. Supp. 2d 578, 588 (S.D.N.Y. 2013), aff’d sub nom. S.M. v. Clash, 558 F. App’x 44 (2d Cir. 2014) (same); S.E.C. v. Wyly, 788 F. Supp. 2d 92, 103 (S.D.N.Y. 2011), on reconsideration in part, 950 F. Supp. 2d 547 (S.D.N.Y. 2013) (“The date of discovery, for purposes of the discovery rule, is the earlier of when the litigant first knows or with due diligence should know the facts that will form the basis for an action.”) (citation omitted); Koch v. Christie’s Int’l PLC, 699 F.3d 141, 149 (2d Cir. 2012) (where statute is silent on the discovery rule, the common law discovery rule is “discovery of the injury . . . is what starts the clock.”) (citation omitted); Twersky v. Yeshiva Univ., 993 F. Supp. 2d 429, 438 (S.D.N.Y.), aff’d, 579 F. App’x 7 (2d Cir. 2014) (“Under the discovery rule, the clock on the limitations period begins to run when the plaintiff has ‘inquiry notice’ of his injury, namely, when he discovers or reasonably should have discovered the injury.”) (citations omitted).
10 See, e.g., United States v. Kubrick, 444 U.S. 111, 122 (1979) (“We are unconvinced that for statute of limitations purposes a plaintiff's ignorance of his legal rights and his ignorance of the fact of his injury or its cause should receive identical treatment.”); Frontera v. United States, 2009 WL 909700, at *9 (W.D.N.Y. Mar. 31, 2009) (“[I]gnorance of the law does not warrant application of the diligence discovery rule.”).
11 SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
12 Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets” (Apr. 3, 3019), https://www.sec.gov/news/public-statement/statement-framework-investment-contract-analysis-digital-assets.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. William K. Pao, an O’Melveny partner licensed to practice law in California, Eric Sibbitt, an O’Melveny partner licensed to practice law in California and New York, David L. Kirman, an O’Melveny partner licensed to practice law in California, and Meg K. Lippincott, an O’Melveny counsel licensed to practice law in California and New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
© 2020 O’Melveny & Myers LLP. All Rights Reserved. Portions of this communication may contain attorney advertising. Prior results do not guarantee a similar outcome. Please direct all inquiries regarding New York’s Rules of Professional Conduct to O’Melveny & Myers LLP, Times Square Tower, 7 Times Square, New York, NY, 10036, T: +1 212 326 2000.
Thank you for your interest. Before you communicate with one of our attorneys, please note: Any comments our attorneys share with you are general information and not legal advice. No attorney-client relationship will exist between you or your business and O’Melveny or any of its attorneys unless conflicts have been cleared, our management has given its approval, and an engagement letter has been signed. Meanwhile, you agree: we have no duty to advise you or provide you with legal assistance; you will not divulge any confidences or send any confidential or sensitive information to our attorneys (we are not in a position to keep it confidential and might be required to convey it to our clients); and, you may not use this contact to attempt to disqualify O’Melveny from representing other clients adverse to you or your business. By clicking "accept" you acknowledge receipt and agree to all of the terms of this paragraph and our Disclaimer.