I am sure that when most people think about the kind of organization that might engage in an Initial Coin Offering (ICO), they typically are thinking of a start-up venture — an enterprise trying to get off the ground. But there have been some high-profile cases of well-established companies trying to jump on board the cryptocurrency bandwagon. For example, Kodak, the iconic film and photographic equipment company that has fallen on hard times in recent years, announced a plan earlier this year to launch KodakCoin, a photography-focused cryptocurrency that is supposed to help photographers manage their collections by creating permanent, immutable records of ownership. (Kodak’s later postponed the planned launch.)
The online retailer Overstock.com is another established company that late last year announced plans for a cryptocurrency offering. Overstock’s cryptocurrency plans were derailed earlier this month after its planned offering drew SEC scrutiny. Now, the company has been hit with a securities class action lawsuit relating to its miscarried cryptocurrency initiative, as discussed below. Though much of what happened to Overstock is company- specific, the sequence of events and the overall circumstances may have some important lessons as the cryptocurrency phenomenon evolves.
Overstock is a publicly traded company. Its shares have traded on NASDAQ since the company’s 2002 IPO. Overstock launched its Medici Ventures division in 2014 to oversee the company’s work in blockchain technologies. On October 25, 2017, Overstock’s CEO Patrick Byrne told CNBC that the company’s majority-owned subsidiary tZero planned to raise up to $500 million, in what at the time would have been the largest-ever ICO. On December 18, 2017, the company announced that tZero was initiating a $250 million offering. The complaint in the securities class action lawsuit described below alleges that based on these initiatives, the company’s share price rose more than 500% between August 2017 and January 2018.
On March 1, 2018, the company announced that it had been notified that the SEC had requested information from the company about its sale of cryptocurrency. The company’s share price declined over 4% on this news.
On March 15, 2018, the company announced that the SEC investigation “could result in a delay of the tZero security token offering, negative publicity for tZero or us, and may have a material adverse effect on us or on the current and future business ventures of tZero.” The company also disclosed that the SEC is conducting an examination of advisers at tZero. The securities suit complaint also alleges that the company disclosed that the company’s Medici unit had lost $22 million in 2017, even though Bitcoin prices had increased over 1,300% during that time. On this further news, the company’s share price declined an additional 5%.
On March 26, 2018, the company announced a secondary offering of 4 million common stock shares. The company’s share price fell an additional 15%.
On March 29, 2018, two Overstock shareholders filed a securities class action lawsuit in the District of Utah, naming as defendants the company, Byrne, and Jonathan Johnson, the President of Medici and a director of the company. A copy of the complaint can be found here. The complaint alleges that the company’s statements about its blockchain initiative and its planned coin offering were false and misleading because they concealed or failed to disclose that “(1) Overstock’s coin offering was highly problematic and potentially illegal; and (2) the Company’s Medici business was hemorrhaging money.” The plaintiffs’ counsel’s March 29, 2018 press release about the lawsuit can be found here.
I know for some readers with a more cynical point of view the Overstock ICO story might elicit a rueful shake of the head. But this story is more than just a 21st century technological morality tale. For starters, there is the context within which Overstock was making its blockchain and cryptocurrency play. According to CoinSchedule (here), in 2017, issuers raised $3.88 billion through 210 ICOs. Pretty impressive, for sure. But in just the first three months of 2018, issuers have already raised $4.9 billion in 158 ICOs. Of the total of nearly $8.8 billion raised in ICOs in 2017 and so far in 2018, $6 billion was raised just in the fourth month period from December 2017 to the end of March. Regardless of how you feel about all of this, you have to acknowledge that this is a serious amount of economic activity.
With these kinds of dollars involved, it is hardly surprising that a wide variety of ventures might try to get in on the act – including even more established enterprises, like, say, Kodak or Overstock. The involvement of these kinds of companies, and others, in cryptocurrency initiatives proves a point that I made at the PLUS D&O Symposium in February, which is that D&O insurance carriers may well say, as most of them have, that they are staying as far away from ICOs and cryptocurrencies as they can – but just the same, they may find that within their portfolio of existing policyholders, there are companies getting drawn into ICO, cryptocurrency or blockchain initiatives. Even carriers that say they have a blanket prohibition on companies involved with these initiatives may find that they nevertheless are insuring companies involved with these digital assets and processes.
There is no doubt that amidst the ICO craze there have been a number of issuers – perhaps many – that have raced ahead with insufficient regard to legal requirements or constraints. The reaction of the SEC and other regulators has been slow and belated. The SEC does at least now seem to be on the beat, as the investigative developments involving Overstock might be interpreted to suggest. The one thing that is interesting to me is that despite the SEC’s recent public warnings about the dangers of cryptocurrencies and more active enforcement stance, the pace of ICO activity doesn’t seem to have slowed at all. To the contrary, in March 2018 alone, 52 ICOs that raised over $2 billion, by far the largest monthly total amount raised on record.
Maybe cryptocurrency is a bubble that will burst. Maybe the SEC’s slow but serious enforcement approach will culminate in a crackdown that knocks out the excesses. But in the meantime, and at least for now, there are going to be more companies, even established companies like Overstock, getting involved with these digital assets.
As the events at Overstock shows, getting involved with cryptocurrency can result in legal complications — like, say, an SEC investigation or a lawsuit. By my count, there have now been a total of ten securities class action lawsuits filed last year and in the first three months of 2018 against companies involved with ICOs, cryptocurrency or blockchain. (My count includes the Overstock lawsuit and the additional ICO-related lawsuit described below.) All of these lawsuits have been filed just in the last five months. Given the surging levels of ICO activity in the recent months, we should anticipate that we will be seeing more of these cryptocurrency and blockchain lawsuits in the months ahead. I suspect strongly that we will see more cryptocurrency-related lawsuits involving established companies – including even publicly traded companies.
The lawsuit against Overstock is different in one important respect from many of the other cryptocurrency and blockchain-related securities suits that have been filed. In most of the other lawsuits, the claimants are persons who think they were misled or fleeced in an ICO. The Overstock lawsuit, by contrast, is not being brought by investors who purchased the cryptocurrency that Overstock planned to offer; rather, the lawsuit is brought by and on behalf of the company’s public shareholders. This is an important difference, because unlike the disappointed ICO investors who generally assert that the ICO issuer improperly failed to register the offered coins or tokens as required under the ’33 Act, the disgruntled Overstock shareholders claims they were misled in violation of the liability provisions of the ’34 Act.
The difference matters, because in order to sustain their claim, the Overstock shareholders must establish that the defendants acted with scienter, whereas the ICO investors do not need to establish that the ICO issuer acted with improper intent. Of course, in order to prevail on their claims, the ICO investors must prove that the coins or tokens they purchased in the ICO are in fact securities within the meaning of the federal securities laws.
By Way of Contrast, An ICO Investor’s Securities Suit: The important point I stressed above about the Overstock coin offering and lawsuit is that the situation involved an established company. There are of course a lot of enterprises involved in the ICO phenomenon that could charitably be described as fledgling. Indeed, some of them may not exist at all, which seems to be the case in connection with the offering that is at the center of another recently filed ICO-related securities class action lawsuit.
On March 29, 2018, Kevin Herberle, an individual who had invested in an offering of digital tokens called Dark Ripple or DRIP, filed a securities class action lawsuit in the Northern District of Illinois against the offering promoter, an individual named Julian Spence (also known as Juvane Bryan Spence). The complaint purports to be filed on behalf of all investors who purchased DRIP tokens. The complaint in the lawsuit (a copy of which can be found here) alleges that Spence used social media and other means of promotion to solicit the purchase of “illusory and economically worthless DRIP digital currency.”
The complaint alleges that Spence launched his efforts to sell the DRIP tokens on October 27, 2017. Spence, the complaint alleges, posted messages on digital currency online forums concerning the value and utility of DRIP tokens that “were simply false.” Spence also allegedly created and distributed marketing materials “extolling the economic value of DRIP” while he “actively concealed the true value, functionality and value of the token.” Spence also allegedly promoted himself as a successful venture capitalist and blockchain entrepreneur, despite lacking any material experience.
The complaint further alleges that on November 2, 2017, Spence launched a presale of the DRIP tokens, promoting the pre-sale by among other things touting the token’s liquidity and even promising a 5% dividend. According to the complaint, “these representations were entirely false and Spence was aware of the falsity of these representations at the time he made them.”
The DRIP token as “never able to obtain the trading volume that Spence had repeatedly promised.” During December 2017, Spence allegedly “became increasingly unresponsive.” By January 3, 2018, Spence allegedly had “effective scrubbed the internet of any mention of DRIP, including having deleted its website.” The complaint alleges that Spence embarked on a plan to convert the proceeds raised in the presale and to launder the funds through other cryptocurrencies.
The class action complaint alleges that Spence violated Rule 10b-5. The complaint also asserts claims for common law fraud; breach of contract; and rescission. (Significantly, the plaintiff filed his securities claim as misrepresentation case under the ’34 Act, rather than as a failure to register securities under the ’33 Act, so in order establish his securities law claim, he will have to plead and prove that the defendant acted with scieter.)
Just as it is no surprise given the amount of money involved in ICO activity that an established company like Overstock might get drawn into getting involved with cryptocurrency, is also not a surprise that the volume of dollars involved might also attract what is alleged in the Spence complaint to be a small-time but nonetheless egregious fraud.
Cryptocurrencies are sometimes described as virtual currencies. In this case, the allegations suggest that the cryptocurrency was so virtual that it doesn’t really seem to have existed at all. There is no doubt that amidst all of the cryptocurrency hype there is the possibility for some serious hoaxes.
There have of course been these kinds of frauds before, perhaps the most baroque of which was Gregor MacGregor’s 19th century scheme in which he convinced investors to purchase bonds in the fictitious country of Poyais, supposedly located in Central America. Part of MacGregor’s swindle was his claim that he ruled the country as “Cacique.” MacGregor’s victims included not only the many investors who lost all of their investment, but as many as 250 British citizens who he induced to settle his “country.” Fewer than 50 of the settlers survived.
Possible Impact of Cyan on Cryptocurrency Litigation?: As I noted in a post last week discussing the decision, the U.S. Supreme Court’s March 20, 2018 opinion in Cyan v. Beaver County Employees Retirement Fund has significant implications for class action securities litigation under the ’33 Act. While I think my post identified many of the decision’s important implications, one other possible implication that did not immediately occur to me is that the decision could have an impact on future class action litigation involving ICOs.
As I noted above, many of the ICO-related securities class action lawsuits have involve allegations that the issuer wrongfully failed to register the offered coins or tokens with the SEC as required under Sections 5 and 12 of the ’33 Act.
In a March 22, 2018 memo (here), Justin Wales of the Carlton Fields law firm raised the concern that the with the Cyan decision, the U.S. Supreme Court “just opened the gates to filing crypto class actions in state court.”
Wales says in the memo that the Cyan decision “provides a road map for plaintiffs” to “venue shop between state and federal courts in order to seek out a jurisdiction that they perceive to be friendlier to class claims or that offer more lenient pleading or discovery standards than available in federal court.” As a result, the decision “could have a major impact on the development of securities case law as applied to the issuance of cryptocurrencies,” especially given that “nearly every issue in the space is an issue of first impression, which could further incentivize venue shopping by class plaintiffs.”
It may be that unless or until Congress acts to remove state courts’ concurrent jurisdiction for ’33 Act claims, “we may see some state courts emerge as the preferred venue for federal securities class claims against token issuers.”
ICOs and Cryptocurrencies Webinar: On May 1, 2018, at 11 a.m. EDT, I will be participating in the Advisen quarterly claims webinar, which will have ICOs and cryptocurrencies as its main topic of discussion. The webinar will be chaired by Advisen’s Jim Blinn, and the other panelists will include Garret Koehn of CRC Insurance Group and Paul Tomasi of E-Risk Services. Information about the webinar including registration instructions can be found here.