Readers will recall that month when Cornerstone Research issued its annual report on securities class action lawsuit filings, the report showed that the number of crypto-related securities suits had soared, with 21 crypto-related suits filed in 2022, compared to only 11 in 2021. In the following guest post, Scott Schechter and Paul Curley take a look at this emerging new trend in securities class action lawsuit filings involving cryptocurrency and other digital asset-related securities suits. Scott and Paul are Partners in Kaufman Borgeest & Ryan’s Coverage Group in New York. I would like to thank Paul and Scott for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Paul and Scott’s guest post.
The title of this article is a quote from Stanford Law School professor Joseph Grundfest that he made earlier this year in connection with the release by the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research of their report on securities class action filings in 2022. According to the report, in 2022, class actions related to cryptocurrency more than doubled to a record 23 as regulatory oversight increased and the cryptocurrency market weakened.
In addition to the increase in private litigation, the SEC also ramped up its oversight. In May 2022, the SEC announced that the Crypto Assets and Cyber Unit would double in size to 50 dedicated positions. And last year, the SEC brought 30 enforcement actions against digital-asset market participants, up 50% from 2021.
Why all this litigation? Some would point to the lack of regulation or at least the lack of clarity of the applicable regulator. A big issue (the big issue?) in crypto is whether tokens are securities (subject to SEC jurisdiction), commodities (subject to CFTC jurisdiction) or virtual currencies (subject to the jurisdiction of FinCen and state regulators).
The SEC has tried to dispel the uncertainty by taking the position that nearly every crypto asset is a security and, as described by some commentators, by regulating by enforcement. Likewise, digital asset owners have seized on the uncertainty to try and recoup losses through litigation.
What does all of this litigation look like? Very broadly speaking, the SEC previously focused on initial coin offerings and currently appears focused on lending / staking, trading platforms and stablecoins. The most frequent claims seem to be charges of unregistered securities offerings under the Securities Act and fraud under the Exchange Act. The remedies sought usually are disgorgement, civil money penalties, and an injunction against further offers or sales of unregistered securities.
With respect to private litigation against public companies, shareholders are usually the plaintiffs and seek damages under the Exchange Act. As for private companies, plaintiffs generally include token purchasers and participants in lending or staking programs and seek rescission or disgorgement under the Securities Act.
And what about D&O coverage for these lawsuits? Well, first, it seems many, if not most, D&O insurers avoid the crypto space given the lack of clarity on regulation and the significant level of litigation. But we’ll come back to that at the end.
As for private company D&O, coverage would seem available for individuals and the entity, subject to any securities exclusion. That raises an interesting issue. The complaints allege the digital assets are securities, defendants argue the assets are something else (like virtual currency, as Ripple is currently arguing in its litigation with the SEC over the XRP token), and the issue is arguably undecided (with regulators taking conflicting positions). Do the allegations of the complaint control under the 4-corners rule? If you get past the securities exclusion issue, is the relief sought covered Loss? Most insurers would take the position that disgorgement and rescission are not covered Loss. Are we in a defense costs-only scenario?
With respect to public company D&O, lawsuits by shareholders (Ryvyl) or the SEC concerning company stock (FTX) are your classic claims and would seem to trigger defense and indemnity for shareholder actions and defense-only for SEC actions (no indemnity coverage for fines, penalties or disgorgement). But what about lawsuits by token purchasers or lenders in staking programs? Or by the SEC concerning a company’s token or staking program? Side A and B coverage seems available, at least for defense. Indemnity depends on the relief sought (damages or disgorgement?). As for Side C, is this another 4-corners rule scenario – allegations of the complaint, which describe the assets as securities, control, even though defendants may vigorously argue that the assets are something else, like a virtual currency?
So, turning back to the apparent unease of most D&O insurers with the crypto space, their reluctance seems perfectly understandable under current circumstances. That said, the crypto industry is huge and probably here for good. Possibly the best thing that could probably happen to crypto companies (and digital asset owners) is clarity of, and actual, regulation. And if such regulation leads to less litigation and more predictability, D&O insurers might become more comfortable with the crypto risk. In the meantime, they’d probably be well-served by being knowledgeable about the space and monitoring it.