Following the hype of Bitcoin, regulatory and other concerns surrounding various forms of cryptocurrency and initial coin offerings (“ICOs”) have taken center stage. As of late last year, the U.S. Securities and Exchange Commission (“SEC”) has started asserting regulatory authority over many of these rapid digital-token sales, even classifying the coins as securities in certain circumstances. In addition, the SEC and the U.S. Department of Justice (“DOJ”) have issued numerous warnings to investors about the potential perils of investing cryptocurrency through ICOs, noting — among other issues — the risk of fraud and hacking and cautioning main street investors of the potential challenges that regulators may face in recovering funds from wrongdoers. As is already becoming evident, market participants may expect an increase in cooperation between U.S. and foreign regulators in rooting out bad actors in the cryptocurrency market and pursuing fraud associated with ICOs. Along with that cooperation, however, may come challenges uniquely tied to the international nature of certain cryptocurrency-based fraud schemes. Some of these cross-jurisdictional challenges were recently highlighted in SEC v. PlexCorps et al., an SEC enforcement action challenging a Canadian ICO in the U.S. District Court for the Eastern District of New York. The SEC Enforcement Division’s newly minted Cyber Unit initiated the lawsuit, marking the first case brought by the Unit since its formation.
In SEC v. PlexCorps et al., 17-cv-7007, the SEC filed a complaint on December 1, 2017 against two Quebec residents, Dominic Lacroix and Sabrina Paradis-Royer, and their unincorporated company PlexCorps. The complaint alleges that the Defendants marketed and sold “PlexCoin,” a form of cryptocurrency, to investors in the U.S. and other countries, resulting in $15 million in fraudulently obtained proceeds. Among other things, the Defendants allegedly made materially false statements and other misrepresentations to investors, including promises of a 1,354% return on investment within 29 days. The Commission also alleged that Defendants had misappropriated investor funds for personal use, despite already being enjoined by a tribunal in Quebec for similar fraudulent conduct involving unregistered securities transactions. On the same day that it filed its complaint, the SEC moved for an asset freeze order and temporary restraining order, seeking to preserve the assets of PlexCorps, Lacroix, and Paradis-Royer for potential recovery. In response, U.S. District Judge Carol Bagley Amon of the Eastern District of New York granted the order and the government’s subsequent request to convert the temporary restraining order into a preliminary injunction against the entity Defendant, PlexCorps. After Defendants obtained counsel, these initial actions taken by the SEC to preserve funds potentially located abroad prompted a heated debate between the parties over whether the Court could exercise personal jurisdiction over the Defendants to adjudicate the government’s allegations against them.
On December 21, 2017, Defendants submitted a pre-motion-to-dismiss letter to the Court, arguing that the SEC had failed to establish personal jurisdiction over the Defendants. In particular, Defendants contended that the SEC had “engaged in a tremendous overreach, toward persons who [were] not subject to personal jurisdiction in this judicial district,” and that “the SEC’s discovery requests in support of its temporary restraining order should be adjourned pending the disposition of defendants’ motion to dismiss.” In addition, Defendants contended that the key “hook” for the SEC’s assertion of personal jurisdiction was an allegation that some investors in the Eastern District of New York had acquired PlexCoin but that this hook was undermined by Defendants’ efforts to: (1) specifically exclude U.S. residents from purchasing the coins and (2) require buyers to confirm that they were not purchasing the coins on behalf of a U.S. citizen. Thus, Defendants argued that — in light of these preventative measures — the complaint failed to allege that their actions would have had a foreseeable effect in New York sufficient to support the Court’s exercise of personal jurisdiction.
The SEC responded on January 5, 2018, contending in a letter to the Court that the complaint alleged over 1,500 transactions involving investors located in the United States and that “[t]his alone [was] more than sufficient to confer personal jurisdiction.” The SEC also noted that it intended to present evidence in the case that Defendants had “explicitly agreed” that its services “would be provided from systems located and controlled within the United States;” that the payment processing services “required consent to the jurisdiction of United States courts;” and that “Defendants purposefully developed their advertisements in English and were aware that United States persons were purchasing PlexCoin.” In addition, the SEC’s complaint cited Section 929P of the Dodd Frank Act as providing an alternative basis for the Court’s assertion of extraterritorial jurisdiction.
The jurisdictional quarrel in PlexCorps highlights the potential for significant challenges in future cross-border cryptocurrency enforcement actions, particularly where coin issuers have taken steps to domesticate sales or other measures to prevent customers located abroad from purchasing tokens or coins. Moreover, the case presents the key issue of whether a defendant’s use of U.S. based payment methods, such as PayPal — standing alone or taken together with other conduct — is sufficient to establish personal jurisdiction in future cases involving allegations of cross-border fraud. The parties attended a pre-motion conference on January 9, 2018 before Judge Amon, where they addressed the issue of personal jurisdiction, but the dispute likely will not be resolved until Defendants’ motion to dismiss is fully briefed.
The PlexCorps case also underscores another important challenge for the SEC in future cross-border enforcement actions targeting fraudulent ICOs: its ability (or inability) to locate and seize the proceeds of fraudulent conduct in cryptocurrency markets that span borders and where proceeds are increasingly fungible and difficult to trace. To this point, in its January 5, 2018 letter to the Court, the SEC also addressed Defendants’ request for a stay of discovery and the issue of asset recovery. The SEC’s argument highlighted the prejudice it had already suffered, because Defendants failed to produce an accounting of certain fund information despite the Court’s order. It stressed that this withheld information was “important given that certain funds were obtained via cryptocurrencies,” and that “[a]lthough Defendants [were] bound by [the] Court’s orders that those funds not be dissipated, there exists no central authority (like with respect to Defendants’ bank accounts) on which the Commission may serve freeze orders for cryptocurrencies.” The government’s concession in its letter regarding the lack of a central processing authority illuminates potential future challenges to the Commission’s ability to locate, trace, account for, and recover fraudulent proceeds resulting from cross-border cryptocurrency schemes. It also echoes a concern raised by SEC Chairman Jay Clayton in his December 11, 2017 statement, in which he warned investors that where “markets span national borders and . . . significant trading may occur on systems and platforms outside the United States . . . risks can be amplified, including the risk that market regulators, such as the SEC, may not be able to effectively pursue bad actors or recover funds.” If not in the PlexCorps case, this concern may be illustrated in future complex cross-border enforcement actions involving off-shore bank accounts and sophisticated money laundering schemes in which tracing and recovery of funds could prove difficult if not impossible, even where the SEC is successful in establishing liability. With that said, increased cooperation between U.S. and foreign regulators could prove crucial to surmounting future obstacles with respect to tracing, locating, and recovering funds.
Businesses and investors should proceed with caution when considering investing in ICOs and other cryptocurrencies located abroad, as the PlexCorps case highlights some of the challenges surrounding asset recovery in fraudulent virtual-currency schemes. However, the PlexCorps case does not implicate all of the challenges that may lie ahead. For instance, future cases may also involve, among other pitfalls for regulators, difficult choice-of-law questions depending on the parties and conduct involved, complex extradition questions in criminal cases, and challenges to U.S. civil and criminal asset forfeiture efforts. A recent scheduling stipulation in PlexCorps provides that the parties will continue to conduct discovery as to the question of the Court’s personal jurisdiction through April 13, 2018, and Defendants will be required to submit a brief in support of dismissal on personal jurisdiction grounds by April 27, 2018. Therefore, although far from a guarantee, businesses and investors should stay apprised of a potentially significant opinion from the Court in spring or summer of 2018 that could have a profound impact on cryptocurrency enforcement efforts.