According to news reports, the amount raised through Initial Coin Offerings (ICOs) in 2017 now exceeds $4 billion. This surge of activity has drawn the attention of regulators. The SEC is clearly stepping up its ICO-related enforcement activity. ICOs are also drawing the attention of securities class action plaintiffs’ attorneys. As I noted in a prior post, plaintiffs’ attorneys have filed several securities class action lawsuits in connection with the Tezos ICO early this year. Now plaintiff attorneys have filed yet another ICO-related securities class action lawsuit, in this case involving the high-profile and controversial Centra Tech ICO.
Between July 30, 2017 and October 5, 2017, Centra ran an ICO in which the company raised over $30 million in digital currency investments in exchange for Centra tokens. The stated purpose of the offering was to fund the company’s business plan to launch a debit card that would link to digital wallets where users had stored their cryptocurrencies, allowing users to purchase items being sold for dollars or other traditional currencies. Centra’s ICO drew a certain amount of notoriety because of high-profile celebrity endorsements from the boxer Floyd Mayweather and rapper DJ Khaled. Centra’s website can be found here. The “white paper” describing the company’s offering and business plan can be found here.
On October 27, 2017, shortly after the company completed its ICO, Centra was the subject of an unflattering profile in the New York Times entitled “How Floyd Mayweather Helped Two Young Guys From Miami Get Rich” (here). Among other things, the article disclosed that on Oct. 5, the company’s co-founders, Sam Sharma and Raymond Trapani, had been indicted by a Manhattan grand jury in connection with their testimony in a July trial involving drunk-driving charges against Sharma. The article also detailed that Sharma and Trapani had no prior professional experience associated with the debit cards they hoped to build. Their prior business experience consisted of running a luxury rental car company. The Times was also unable to confirm with the major credit card companies the supposed business arrangement Centra had described on its website.
As detailed in a November 7, 2017 Business Insider article (here), shortly after the Times article appeared, Centra announced in a blog post that Sharma and Trapani “are stepping aside.” According to the Business Insider article, while the company has not yet distributed debit cards to customers, it plans to do so before the end of the year. The article also quotes the company’s general counsel as saying “I truly believe that the product will be developed in the near future. The money is not in jeopardy. It’s certainly not a scam.”
The Securities Lawsuit
On December 13, 2017, an investor who purchased Centra Tech tokens in the Centra ICO filed a securities class action lawsuit in the Southern District of Florida against the company, Sharma, Trapani, and two other Centra Tech officers. A copy of the complaint can be found here. The complaint alleges that the defendants violated sections 12(a)(1) and 15(a) of the Securities Act of 1933 in connection with the ICO “by offering and selling unregistered securities in direct violation of the Securities Act.” The lawsuit purports to be filed on behalf of all investors in the Centra ICO.
Among other things, the complaint alleges that in connection with the offering the defendants “made a feeble attempt” to portray the ICO as a sale of “utility-based tokens” that were “not securities, shares or investments.” However, the complaint alleges, the Centra ICO was “a clear offer and sale of securities” because defendants had represented that the Centra tokens would be worth more than the Etherium or other cryptocurrencies used to purchase the tokens. The defendants also allegedly referred to ICO participants as “investors” and allegedly stressed the “growth potential” of the Centra tokens.
The complaint stresses the need for “immediate judicial intervention to preserve Plaintiffs’ and Centra ICO investors’ significant financial interests.” In his complaint, the plaintiff seeks “compensatory, injunctive a rescissory relief, providing rescission and repayment of all investments into the Centra ICO, and conserving such funds until repayment.”
ICOs continue to be all the rage. There were four different articles about bitcoin and cryptocurrencies in today’s Wall Street Journal. The attention and interest in ICOs seem likely to continue as long as the price of bitcoin and other cryptocurrencies continue to soar. Eventually the price for these digital currencies will come back down to earth, which undoubtedly will leave a host of disappointed (and possibly angry) investors behind.
While the day of reckoning for cryptocurrency valuations may lie ahead, legal and regulatory concerns surrounding ICOs have already started to accumulate. The SEC may have been a little bit slow to get off of the mark when it comes to policing the ICOs, but recent events strongly suggest the SEC is getting ready to crack down. Its actions so far suggest the agency intends to target ICO companies for the sale of unregistered securities. (The legal question of when an instrument is a security and when it must be registered was detailed in a guest blog post on this site earlier this week.)
As this new lawsuit against Centra Tech and the earlier securities class action lawsuits filed against Tezos show, ICO investors now apparently are increasingly willing to assert securities law violations against ICO sponsors as well. At a minimum, it appears that ICOs have caught the attention of plaintiffs’ attorneys. A significant downturn in the price of digital currencies could well attract even further attention from the plaintiffs’ bar.