Late last month, when Cornerstone Research released its report on securities class action lawsuit filings in the year’s first six months, it noted that an important first half development was the significant number of suits filed against cryptocurrency and other digital asset-related companies. The recent rise in the number of crypto-related securities suits undoubtedly is related at least in part to the turmoil in the marketplace for digital assets. Last week, the cryptocurrency exchange Coinbase became the latest digital asset company to get hit, as a plaintiff shareholder filed a securities class action lawsuit against the company and certain of its directors and officers. A copy of the complaint can be found here. In addition to the securities lawsuit, the same day a separate plaintiff shareholder filed a shareholder derivative lawsuit against the company as well. The derivative lawsuit complaint can be found here.
Coinbase was founded in 2012 and operates a cryptocurrency exchange. The company grew rapidly and eventually became the largest cryptocurrency exchange in America. On April 14, 2021, Coinbase became a publicly traded company on the Nasdaq exchange via a direct stock listing. Eventually the company’s market capitalization rose to over $80 billion. As detailed in an August 6, 2022 Wall Street Journal article (here), with the recent collapse of the market for cryptocurrencies, the company’s market capitalization has also fallen, to a recent low of roughly $21 billion.
The Securities Lawsuit
On August 4, 2022, a plaintiff shareholder filed a securities class action lawsuit in the District of New Jersey against the company; Brian Anderson, the company’s founder and CEO; and the company’s CFO. The complaint purports to be filed on behalf of a class of investors who purchased the company’s securities between April 14, 2021 (the date of the company’s direct offering) and July 26, 2022 (the date Bloomberg reported that the company is facing an SEC probe into whether it improperly let Americans trade digital assets that should have been registered as securities).
The new securities complaint also refers to the company’s May 2022 disclosure that “Because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our generally unsecured creditors.” The complaint asserts that the company’s share price decline over 26% on this disclosure. The complaint also alleges that in later statement, Armstrong apologized and stated that the company “should have updated our retail terms sooner, and we didn’t communicate proactively when this risk disclosure was added.”
The complaint alleges that the during the class period, the defendants failed to disclose that: “(i) Coinbase custodially held crypto assets on behalf of its customers, which assets Coinbase knew or recklessly disregarded could qualify as property of a bankruptcy estate, making those assets potentially subject to bankruptcy proceedings in which Coinbase’s customers would be treated as the Company’s general unsecured creditors; (ii) Coinbase allowed Americans to trade digital assets that Coinbase knew or recklessly disregarded should have been registered as securities with the SEC; (iii) the foregoing conduct subjected the Company to a heightened risk of regulatory and governmental scrutiny and enforcement action; and (iv) as a result, the Company’s public statements were materially false and misleading at all relevant times.”
The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the plaintiff class.
The Derivative Lawsuit
On August 4, 2022, a plaintiff shareholder filed a shareholder derivative lawsuit in the District of Delaware against Armstrong and certain other company directors and officers, as well as the company itself as nominal defendant. The complaint alleges that in company filings, and in particular in the offering documents issued in connection with the company’s April 2021 direct listing, the defendants violated the Securities Act and breached their fiduciary duties by making false and misleading statements or omissions.
Specifically, the complaint alleges that the defendants misrepresented the company’s proprietary “platform” and its “flywheel growth strategy.” Among other things, the complaint alleges that the as a result of a heavy influx of new users, the company experienced a “breakdown” in its operations, “platform disruptions, and a rupture of the “flywheel cycle” that previously had been “responsible for the company’s historical growth.” The complaint alleges that the defendants’ efforts to increase Coinbase’s numbers in advance of the direct listing “backfired,” leaving the Company and its newfound investors damaged and vulnerable to competition. The company, the complaint alleges, continued to represent to investors that “the fundamentals behind Coinbase’s historical success were still in place and functioning as normal.” Investors who purchased shares in the company’s direct offering “made an investment that was materially different and substantially riskier than what had been represented” in the company’s offering documents.
Coinbase was not sued in these two new lawsuits simply because it is a company involved with cryptocurrencies. Indeed, many companies – not just crypto companies – that experience operating difficulties early in their lives as publicly traded companies get hit with securities suits. However, Coinbase’s existence as a crypto-related company definitely played into this litigation.
Certainly, the new securities suit reflects several peculiar features of Coinbase as a company in a crypto-related business. The crypto business is all so new that there are a host of unanswered legal and regulatory questions surrounding the companies in the industry. The questions about the bankruptcy status of the customer assets held by Coinbase is a good example of the kind of legal issues that are murky simply because they have not come up before. The news that the SEC is investigating Coinbase for possible involvement with trading unregistered securities encapsulates the cloud of regulatory uncertainty that surrounds cryptocurrencies, and in particular whether crypto coins, tokens, and other digital assets are “securities” within the meaning of the law. Given these legal uncertainties and ambiguities, it arguably should come as no surprise that companies involved with cryptocurrencies and other digital assets have been plagued with litigation.
Indeed, these two new lawsuits are not even the first lawsuits to be filed against Coinbase itself during its roughly 15-month life as a publicly traded company. A prior securities class action lawsuit, first filed in July 2021, previously alleged that in connection with the company’s direct listing the company misrepresented the stability of its platform and otherwise misled investors. A copy of the consolidated amended complaint in that prior securities suit can be found here. In addition, a separate securities class action lawsuit was first filed in October 2021, alleging that Coinbase had failed to register as a securities exchange in violation of the federal securities laws. A copy of the amended complaint in this lawsuit can be found here. Finally, in May 2022, Coinbase was hit with a securities suit relating to the trading of the GYEN cryptocurrency on its platform. A copy of the complaint in the GYEN lawsuit can be found here.
The mounting levels of securities and other litigation that has dogged Coinbase in its short life as a publicly traded companies shows how the regulatory uncertainty and operating challenges generate litigation risk – and not just for Coinbase, but for other companies in the crypto business. The prospects for further litigation involving these companies seems substantial. Indeed, the recent turbulence in the crypto markets adds to this substantial risk. The trend noted at the outset of this post concerning the litigation against crypto companies in the year’s first six months seems likely to continue, for the balance of the year, and beyond.