As I have previously noted, the dramatic recent rise in Initial Coin Offerings (ICOs) and in transactions involving cryptocurrencies generally has been accompanied by a number of securities class action lawsuits alleging, among other things, that the digital currencies’ issuers or sponsors failed to register the coins or tokens as securities with the SEC as required by the federal securities laws. These lawsuits raise a number of novel and interesting issues, including jurisdictional issues and other concerns arising from the cross-border nature of many of these transactions. On August 7, 2018, in a detailed decision in the securities class action relating to the 2017 Tezos ICO, Northern District of California Judge Richard Seeborg ruled on a number of these threshold issues. Among other things, Judge Seeborg’s decision contains an interesting analysis of the place of the ICO transactions took place in order to determine whether or not the U.S. securities laws apply. Judge Seeborg’s order can be found here.
The Tezos blockchain project was organized by Arthur and Kathleen Breitman, a husband and wife team based in Northern California, though their company, Dynamic Ledger Solutions. During the organization and planning stages of the Tezos ICO, Timothy Draper, a venture capitalist, made a minority investment in DLS. The Breitmans and DLS established a non-profit foundation, the Tezos Foundation, in Switzerland, to oversee the planned ICO. In addition, Bitcoin Suisse, provided intermediary services in connection with the planned ICO, including conversion of U.S. dollars into Bitcoin and Etherium, transfer of cryptocurrency, and creation of digital wallets. The Tezos ICO commenced on July 1, 2017, raising the market equivalent of approximately $232 million in Bitcoin and Etherium by its July 14 close.
In November 2017, a number of investors filed securities class action lawsuits in the U.S. against the Breitmans, DLS, Draper, the Foundation, and Bitcoin Suisse, alleging among other things that the ICO participants violated the federal securities laws through the sale of unregistered securities. The various actions were consolidated, and a lead plaintiff selected. The plaintiff filed a consolidated amended complaint. The defendants filed motions to dismiss on jurisdictional grounds.
The August 7, 2018 Order
In his August 7, 2018 Order, Judge Seeborg granted in part and denied in part the defendants’ motions to dismiss. First, Judge Seeborg granted Bitcoin Suisse’s motion to dismiss based on lack of personal jurisdiction, but denied the Foundation’s equivalent motion. Judge Seeborg concluded that the plaintiff had failed to allege sufficiently that Bitcoin Suisse purposefully directed activity toward the U.S. However, he found that the plaintiff had sufficiently alleged that the Foundation had purposefully directed activity toward the U.S., among other things using the Breitmans as a de facto marketing arm and engaging in little or no marketing of the ICO anywhere other than the U.S. The Foundation “encouraged U.S. citizens to participate in the ICO, it made it easy for them to do so,” and as a result most of the 30,000 ICO contributors were based in the U.S.
Judge Seeborg then turned to the Foundation’s motion to dismiss on forum non conveniens grounds. In seeking dismissal on these ground, the Foundation relied heavily on the forum selection clause in the ICO’s “contribution terms,” designating Europe as the site for all ICO-related participation and litigation. While forum selection clauses are normally given with in forum non conveniens analyses, Judge Seeborg was disinclined to allow the clause to control, since it was located on the tenth page of a twenty page document posted on the Tezos website, and because a single sentence directed users to refer to legal documents. Judge Seeborg denied the Foundation’s motion to dismiss on forum non conveniens grounds, but did so without prejudice to its renewal after discovery if it shows the plaintiff’s actual knowledge of the agreement.
The Foundation also moved to dismiss based on the U.S. Supreme Court’s decision in Morrison v. National Australia Bank, arguing that the application of the U.S. securities laws here would result in an improper extraterritorial application of the Exchange Act. In making this argument, the Foundation relied on the reference in the ICO Contribution Terms, which designated the British Crown outpost of Alderney as the place where the transactions took place. Judge Seeborg declined to decide the issue based on this designation, and instead looked at the place of the actual rather than the contractual situs of the transaction. In this connection, he asked “where does an unregistered security, purchased on the internet, and recorded ‘on the blockchain,’ actually take place?”
Judge Seeborg concluded that the plaintiff participated in a transaction in the U.S. because the sale took place on a website that was hosted on a server in Arizona and was run primarily by Arthur Breitman in California. Also, the plaintiff learned about the ICO and participated in response to marketing that almost exclusively targeted U.S. residents. The plaintiff’s contribution to the ICO became “irrevocable” only after it was validated by a network of global nodes clustered more densely in the U.S. than in any other country. These factors together, the Judge said, “support an inference that [the plaintiff’s] alleged securities purchase occurred inside the United States.”
Finally, Judge Seeborg considered various of the defendants’ motions to dismiss the Section 12 claims against them, arguing that they were not “statutory sellers” within the meaning of the statute. Judge Seeborg granted Draper’s and Bitcoin Suisse’s motions, ruling they was not sufficiently involved in the transaction to trigger his potential liability. However, he denied the equivalent motion of DLS.
Judge Seeborg’s opinion does not get to the most fundamental issues that these ICO-related cases raise – that is, his ruling does not address the question of whether or not the Tezos coins or tokens are securities, nor does he address the question of whether the failure to register the coins or tokens with the SEC violated the federal securities laws. These are issues for another day.
However, his analysis of the other threshold issues addresses a number of other issues that many of the various ICO and cryptocurrency lawsuits present. Many of these cases involve a variety of defendants that were involved in the ICO project but that are located outside the U.S. The claims against these defendants in other cases will raise the same kind of personal jurisdiction questions that Judge Seeborg addressed here. In that connection, Judge Seeborg’s finding that the plaintiff’s allegations were sufficient to establish personal jurisdiction over the Foundation are interesting.
But perhaps the most interesting part of Judge Seeborg’s opinion is his analysis of whether or not the U.S. securities laws apply to transactions taking place in the ill-defined omnipresence of the Internet. In many of these cases, courts will be asked to address the question, as Judge Seeborg was asked here, “where does [the sale of] an unregistered security, purchased on the internet, and recorded ‘on the blockchain,’ actually take place?” This question is critical here and in the other ICO-related lawsuits, because of the answer to the question is somewhere other than the U.S., the U.S. securities laws don’t apply to the transaction and the plaintiffs’ claims cannot go forward.
In answering these questions here, Judge Seeborg identified a number of factors he considered relevant in concluding that the transaction took place in the U.S. – the location of a website hosting server in the U.S., and the direction of that website within the U.S.; the ICO marketing in the U.S. and targeting U.S. residents; and the validation of the transaction on a global network with nodes clustered most densely in the U.S.. which, Judge Seeborg concluded to mean that the transfer became “irrevocable” in the U.S. Judge Seeborg noted that no one of these factors alone is sufficient, but collectively they “supported an inference” that the transaction took place in the U.S.
The factors Judge Seeborg considered in answering this question will be instructive for other courts considering similar questions in other ICO cases. The inquiry is clearly fact-intensive and will be highly dependent on the allegations and the actual circumstances involved. The fact that the factors are considered collectively and that no one factor is determinative is important. The obvious implication is that different courts approaching different circumstances might reach different conclusions on the question of where the transaction took place. However, Judge Seeborg’s analysis identifies the kinds of factors that will be relevant for courts to consider.
Most of the ICOs that have been the subject of securities lawsuits in the U.S. involve foreign defendants and entities. All of these cases will raise threshold questions of whether or not it is appropriate to expect these foreign parties to appear and defend themselves in the U.S., and also will raise the question of whether or not the U.S. securities laws even apply to the transactions. Judge Seeborg’s is the first to address these points, making his decision interesting and possibly instructive for the other cases.