The cryptocurrency industry, already facing scrutiny from the SEC, DOJ, CFTC, state regulators and others, also has to contend with civil lawsuits, which may be primed to start to gain popularity among private plaintiffs and plaintiff firms. Last week in California, a federal judge appointed lead counsel for a putative class of investors who had filed suit in January 2017 against a cryptocurrency startup focused on the legalization of marijuana. The case, captioned Davy v. Paragon Coin Inc., 18-cv-00671 (N.D. Cal.), centers on plaintiffs’ claims that defendants raised at least $70 million in a 2017 ICO by offering and selling unregistered securities in violation of Sections 12 and 15 of the 1933 Securities Act.
At the heart of this case is the question everyone in the cryptocurrency industry wants to know the answer to: is an ICO a “security” under the securities laws. As we noted in our post last week, a federal judge in Brooklyn is grappling with the same question in a criminal proceeding. Private plaintiffs like Davy are able to bring purported class action lawsuits because Section 12(a)(1) of the Securities Act provides for a private right of action for private plaintiffs against any person who offers or sells securities in violation of Section 5 of the Securities Act.
In early April 2018, defendants in Paragon filed a motion to compel arbitration or in the alternative dismiss the complaint, arguing that plaintiff voluntarily agreed to arbitration when he purchased his Paragon tokens and also that plaintiff’s complaint fails to state a claim for which relief may be granted because plaintiff fails to allege sufficient facts that demonstrate that the Paragon token is a “security.” It is noteworthy that defendants, in arguing that the ICO was not an “investment contract”, only challenge the third prong of the Howey test – whether there was an expectation of profits to be derived solely from the efforts of others. Defendants did not challenge the first and second prongs of the Howey test, which require (1) an investment of money (2) in a common enterprise. In contrast, as we noted in our post last week, in the criminal context Zaslavskiy argued in his motion to dismiss that the Government had not sufficiently alleged any of the three prongs of the Howey test. Opposition and reply briefs in Paragon are due in June and the judge has set a hearing date for August 3, 2018.
The Paragon case is certainly not the first case to be filed against ICO issuers. Other actions include:
- November/December 2017 (In re Tezos Securities Litigation, Nos. 17-cv-06779,17-cv-06829, 17-cv-07095 (all consolidated in N.D. Cal.)) – Plaintiffs filed purported class action lawsuits alleging that defendants offered and sold Tezos tokens in violation of the Securities Act of 1933 because the tokens are “securities.” Briefing on motions to dismiss the consolidated complaint is currently underway.
- December 13, 2017 (Rensel v. Centra Tech Inc., No. 17-cv-24500 (S.D. Fla.)) – Plaintiff filed a purported class action complaint alleging that the Centra ICO constituted an unregistered offering and sale of securities. In February 2018, defendants filed a motion to compel arbitration and/or in the alternative motion to dismiss for lack of subject matter jurisdiction and failure to state a claim. A hearing on the motion to compel arbitration/motion to dismiss was held on April 20. No decision has been issued.
- December 19, 2017 (Hodges v. Monkey Capital, LLC, No. 17-cv-81370 (S.D. Fla.)) – Plaintiffs filed a lawsuit alleging defendants violated the Securities Act by fraudulently issuing securities ahead of a promised ICO. Plaintiffs filed an amended complaint in March 2018 and earlier this month entered default judgments against defendants for failure to appear or respond to the complaint.
- December 21, 2017 (Balestra v. ATBCOIN, LLC, No. 17-10001 (S.D.N.Y.)) – Plaintiffs filed a purported class action lawsuit against defendants alleging that ATBCoin violated the Securities Act by issuing unregistered securities. In April 2018, Defendants filed a motion to dismiss and briefing on that motion is complete.
- December 28, 2017 (Stormsmedia, LLC v. Giga Watt, Inc., No. 17-cv-00438 (E.D. Wash.)) – Plaintiff filed a purported class action lawsuit alleging that defendants violated the Securities Act by issuing unregistered securities. Plaintiff settled the case in January 2018 and the case was dismissed.
- March 19, 2018 (Moss v. Giga Watt, Inc., No. 18-cv-00100 (E.D. Wash.)) – Plaintiff filed a lawsuit alleging that defendant violated the Securities Act by issuing unregistered securities. Defendants’ responsive pleading is due on or before July 2, 2018.
It is likely that private plaintiffs and plaintiff firms will continue to bring lawsuits regarding ICOs, in particular if plaintiffs start to have some success in any of the already-filed lawsuits. Plaintiff firms are actively advertising that they are investigating potential claims related to certain ICOs and are urging investors in those ICOs to contact them to discuss filing suit. To the extent that any regulator decides to put restrictions on ICOs or decides that ICOs are securities, the industry can expect to see a deluge of lawsuits related to recent ICOs.