According to the latest update on the Coinschedule website (here), there have been a total of 228 initial coin offerings so far this year through mid-October, raising a total of over $3.6 billion. At least five of this year’s ICOs have raised over $100 million. This burgeoning activity notwithstanding, ICOs are at the center of controversy. Among other things, China and South Korea have banned ICOs. The SEC has already shown its willingness to pursue enforcement actions against ICO sponsors, as discussed further here. And now a high-profile statement by one of the country’s leading securities regulation experts suggests even greater scrutiny may lie ahead. In the meantime, as discussed below, ICO and cryptocurrency-related litigation appears to be proliferating.
A November 26, 2017 New York Times article entitled “Initial Coin Offerings Horrify Former S.E.C. Regulator” (here) quotes Stanford Law Professor and former SEC Commissioner Joseph Grundfest as saying “ICOs represent the most pervasive, open and notorious violation of the federal securities laws since the Code of Hammurabi.” He went on to refer to the “almost comedic quality” of the securities law violation involved with ICOs. While noting that there have been relatively few enforcement actions involving ICOs, Grundfest clearly expects that there will be more. He said “We’re waiting to see a whole bunch of enforcement actions in this space, and we wonder why they haven’t happened yet,” adding “I hope what they are doing is planning on a sweep of 50 ICOs.”
The most obvious securities law objection to ICOs is that if the coin or token offered in the offering transaction is a security, the offering would be in violation of the federal securities laws if not registered with the SEC — which most are not. On the question of whether or not the coin or token is a security, ICOs sponsors will want to heed the recent words of SEC Chair Jay Clayton. As reported in the November 9, 2017 Wall Street Journal (here), Clayton commented at a recent securities law conference that “I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security.”
The Times article to which I linked above also quotes Clayton as saying that “Where we see fraud, and where we see people engaging in offerings that are not registered, we are going to pursue them because these types of things have a destabilizing effect on the market.”
So not only do you have a prominent legal scholar and former regulator calling for the SEC to crack down on ICOs but you have the current head of the SEC effectively saying that the agency intends to crack down on offerings that should have been registered but that were not.
While Professor Grundfest is critical of the SEC for not being sufficiently active in pursuing enforcement actions against ICO sponsors that should have but fail to register the offerings with the SEC, investors themselves may be taking matters in their own hands by pursuing their own remedies.
As I noted in a prior blog post about ICOs (here), investors in the Tezos ICO have launched a class action lawsuit against the offering company and certain of its executives. The July 2017 Tezos ICO, in which the sponsoring organization raised $232 million, has been mired in controversy. In early November, investors filed a purported class action lawsuit on behalf of investors who participated in the Tezos ICO. The lawsuit, which was filed in California state court, names as defendants The Tezos Foundation, which conducted the offering; Dynamic Ledger Solutions, which claims to own all Tezos-related intellectual property; and against Kathleen and Arthur Brightman, who organized the offering. In his complaint (a copy of which can be found here), the plaintiff alleges that the Tezos tokens were not registered with the SEC and that many of the representations that the offering’s sponsors made in the run-up to the offering were “either exaggerations or outright lies.”
On November 13, 2017, a second Tezos investor filed a separate class action lawsuit in connection with the Tezos ICO. This second lawsuit, filed in the Southern District of Florida, is also filed against the Tezos Foundation, Dynamic Ledger Solutions, and the Brightmans. Among other things, the Florida lawsuit seeks damages based on allegations that the defendants engaged in the unregistered offering of securities in violation of Sections 5(a) and 5(c) of the Securities Act of 1933, as well as in violation of the Florida securities laws. The Florida complaint (a copy of which can be found here) also alleges that the defendants engaged in fraud in connection with the sale of securities in violation of Section 17 of the ’33 Act and the equivalent section of the Florida securities statute. The complaint also asserts a count for unfair or deceptive trade practices. The Florida complaint also asserts a claim for rescission.
Now two more purported securities class action lawsuits have been filed in connection with the Tezos ICO. On November 26, 2017, another Tezos investor filed a purported securities class action lawsuit in the Northern District of California against the same defendants. A copy of the complaint in this lawsuit can be found here. This complaint also alleges that the Tezos ICO sponsors failed to register the offering with the SEC in violation of the securities laws, and the plaintiff seeks to have the transaction rescinded.
Finally, on November 28, 2017, another purported securities class action lawsuit was filed in the Northern District of California in connection with the Tezos ICO. This latest complaint (a copy of which can be found here) alleges that in violation of Sections 12 and 15 of the ’33 Act the Tezos ICO sponsors offered and sold unregistered securities. This latest action also seeks rescission of the transaction.
The various Tezos lawsuits have only just been filed and it remains to be seen how they will fare. Among other interesting issues that may have to be addressed in the lawsuits are the relevance and impact of various terms and conditions of the Tezos ICO. Among other things, the ICO terms and conditions purported to designate Swiss law as the governing law; designate in a forum selection clause “the ordinary courts of Zug, Switzerland” as the designated forum; and to prohibit offering participants from participating in class actions. The claimants in the various lawsuits have already taken the position that these provisions are void or unenforceable. The effects of these provisions are among the many interesting issues that courts likely will have to address as these cases go forward.
It is worth noting that the Tezos lawsuits are not the first cryptocurrency-related class action lawsuits. As reported in an August 1, 2017 Daily Business Review article (here) in connection with a class action lawsuit filed in the Southern District of Florida against cryptocurrency exchange Project Investors, Inc. which did business as Cryptsy, Judge Kenneth Marra ordered the return of 11,000 bitcoins worth about $30 million at the time. (At the time, bitcoins were trading at about $2,700; more recently they have been trading for over $10,000.) The plaintiff investors alleged that the defendant had stolen their money and fled to China. A default judgment was entered against the defendant, which failed to appear. The lawsuit was originally filed in February 2016.
The same law firm that filed the Cryptsy class action lawsuit also filed a purported class action lawsuit in July 2017 against Payward Incorporated, which operates the Kraken cryptocurrency exchange. The claimants contend they lost 3,414 units of the Ethereum cryptocurrency during a market flash crash.
ICOs may represent a new phenomenon, but the ICO landscape is already crowded with ICO and cryptocurrency-related litigation, and further enforcement action may yet follow. Whatever the ultimate business and financial promise of ICOs ultimately may prove to be, they do seem to promise a great deal of business for the ICOs law firms.
For a very detailed review of the “the federal and state regulatory onslaught in store for the purveyors of ICOs is imminent and will ensnare a broad range of ICO market participants,” please review to the guest post published earlier this month on this site, here.