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Five Crypto-Securities Trends That Spell More Lawsuits in 2018二月 8, 2018
A recent wave of private crypto-securities lawsuits points to a potential tsunami of such actions on the horizon. In just the past four months—notwithstanding that even regulators have made clear that whether a cryptocurrency is a “security” requires a case-by-case analysis—at least thirteen cases have been filed in courts across the nation challenging initial coin offerings (ICOs) under federal and state securities laws. Eleven of the thirteen are currently pending: five in the Northern District of California, three in the Southern District of Florida, one in the Southern District of New York, one in the Western District of Kentucky, and one in the District of Minnesota. In addition, two have been voluntarily dismissed, one in the Southern District of Florida and the other in the Eastern District of Washington. (You can find the complete list below.)
The range of claims in these recent lawsuits—brought under everything from the federal securities laws to state unfair-competition laws to false-advertising laws to blue-sky laws—suggests that plaintiffs’ lawyers are still honing their strategy. But some patterns have already emerged. We have identified five trends—from the soaring values of cryptocurrencies to the growing involvement of mainstream securities plaintiffs’ firms—that should have market participants bracing themselves for even more suits in the year ahead.
- More regulatory actions in 2018 will spur more private crypto-securities lawsuits. Given the nascent stage of private cryptocurrency actions, plaintiffs’ lawyers have been relying heavily on the government to frame their cases for them. In ten of the private crypto-securities suits filed to date, the plaintiffs leverage as much as possible the SEC’s recent reports, comments, and enforcement actions relating to cryptocurrencies and ICOs. For example, plaintiffs in those ten cases all tout the SEC’s July 25, 2017 investigative report, which found that the tokens offered and sold in an ICO by “the DAO” constituted securities, as proof that the tokens they bought are also securities subject to state and federal securities laws. Many also quote SEC Chairman Jay Clayton’s November 8, 2017 comment that he has “yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security” to insinuate that tokens—including those of defendants—are securities. And several complaints refer to the SEC’s September 29, 2017 enforcement action against REcoin and Diamond Reserve Club, which allegedly misrepresented that they had raised between $2 million and $4 million from investors, when they had in fact raised only $300,000. Now that the government has its sights trained on cryptocurrencies and ICOs, we will likely see more pronouncements, regulations, and enforcements in coming months, which will surely spur even more securities cases. Thus, even though many cryptocurrencies may not constitute “securities,” companies issuing cryptocurrencies should beware that plaintiffs are increasingly likely to file suit under federal and state securities laws.
- The volatility of cryptocurrency prices means more lawsuits. Unlike traditional securities cases, which usually follow a drop in prices, private crypto-securities suits have recently been fueled by a rise in prices. In many ICOs, token buyers paid with cryptocurrencies such as Bitcoin or Ether. Given the dramatic appreciation of Bitcoin and Ether in recent months, many token buyers now would rather have their Bitcoin and Ether back. Thus, in all 13 of the private crypto-securities suits, many of which involve ICOs held in mid-2017, plaintiffs seek rescission (i.e., to undo their token purchase). In recent weeks, however, many cryptocurrencies are down 70% or more. This significant drop in price also will likely spur numerous private crypto-securities lawsuits as token buyers look for ways to recoup their losses.
- Successful ICOs beget more suits. Unfortunately, the more successful an ICO, the more attractive the amount in controversy is to plaintiffs’ lawyers. It comes as no surprise, therefore, that the Tezos Foundation—whose $232 million sale for its “Tezzies” tokens broke records at the time—is named in five private crypto-securities suits. Similarly, Bitconnect, a cryptocurrency investment platform whose proprietary token had a market cap of over $2.5 billion in January 2018, is now the subject of three separate suits. Each of the other ICOs giving rise to lawsuits is estimated to have raised less than $50 million. As ICOs in 2018 threaten to break last year’s record, more will likely attract lawsuits.
- Experienced attorneys are sensing opportunity. A growing number of mainstream securities plaintiffs’ firms are entering the fray, suggesting that they increasingly see private crypto-securities suits as viable cases worth investing in. For example, in the Tezos cases, eight firms—many of which typically appear in large securities cases—have applied to serve as lead plaintiffs’ counsel.
- Jurisdictional tactics could open the floodgates. Because many ICOs are borderless and attract token buyers from around the world, plaintiffs need to find ways for U.S. courts to assert jurisdiction. So far, plaintiffs have generally succeeded in establishing U.S. jurisdiction over crypto-companies. In eight cases, plaintiffs filed suit in the jurisdiction where at least one of the defendants is located. In five cases, though, plaintiffs attempted to assert jurisdiction where they purportedly purchased the tokens; in one of those cases, involving Tezos, the plaintiff voluntarily dismissed without prejudice in favor of the other pending Tezos actions. If plaintiffs are able to successfully establish jurisdiction based on wherever they bought a token, many crypto-companies—even those with minimal U.S. contacts—may find themselves haled into American courts.
As cryptocurrencies and ICOs continue to proliferate, so will lawsuits. Given that regulations and laws governing ICOs are still developing, cryptocurrency market participants need to fully consider and evaluate all these trends as they weigh their next steps in the burgeoning cryptocurrency industry.
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 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, Taylor Evenson, an O'Melveny associate licensed to practice law in California and Illinois, and Andrew Weisberg, an O'Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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