Crypto Caselaw Minute #7 — 10/18/2018
Another week, another CCM. This week Palley and I are very fortunate to welcome a guest writer who will illuminate a recent German court decision for us: Dr. Nina-Luisa Seidler. Dr. Seidler breaks down a recent criminal court decision that may send shock waves through the crypto community in Germany.
We also give an update on ongoing Ripple litigation, and wassa wassa wasssaaaaupppppp, the BITCONNNNNNNNNNECT class action consolidation. (Summaries by Rosario are “NMR”; those by Palley are “SDP”; this week’s summary by Dr. Nina-Luisa Seidler is “NLS”).
As always, any opinions expressed here are our personal opinions only, are not legal opinions, are not authorized or endorsed by any past, present or future client or employer. And we may change our minds — we contain multitudes).
In re Bitconnect Securities Litigation, 9:18-cv-80086-DMM, (S.D. Fla, Oct 11, 2018) [NMR].
This case is the next phase in the Bitconnect saga. In particular, multiple pending class action lawsuits around the country are attempting to consolidate into one class action suit. For those that don’t remember, or were living under a crypto rock, Bitconnect was the alleged ponzi scheme that guaranteed investor returns of 10% per month while leveraging a referral program for investors. Incidentally, the Bitconnect team claimed to use a trading “bot” to manage the trades and help secure investors profits.
This amended complaint is long. 105 pages long to be exact. On the one hand this complaint is fairly typical in that it walks through the various actions, such as alleged securities laws violations, as well as alleged deceptive and unfair trade practices, and other alleged violations. What is more interesting is the list of defendants and the sheer amount of material provided by the plaintiffs.
The plaintiffs are going after Bitconnect, its developers, a considerable number of Bitconnect promoters, as well as YouTube where some of the most prolific Bitconnect promoters resided. On that point, this complaint is rife with references to social media posts, screenshots, a legion of YouTube links, and even Google search trend results. In an odd cosmic twist, the Google search trend results are used to try and show negligence on YouTube’s part. Essentially, a lot of people were searching to find out if Bitconnect was a scam, and the argument goes that that was convincing data that YouTube should have known better than to facilitate Bitconnect’s operations. If anyone needs any more reminding that everything you put on the Internet is on the record, and potentially evidence, then they are a lost cause. [SDP comment: Palley is skeptical about suing YouTube for negligence — where’s the duty? — but allows that it is a creative theory].
What is going to happen with this case? Well, no one knows. Assuming the plaintiffs win their lawsuit, I suspect the people behind Bitconnect may have some value stashed away, but I do know for certain that YouTube has deep pockets. In a different cosmic twist, the man most associated with Bitconnect is nowhere to be found in this lawsuit. Fair winds Carlos Matos.
Criminal Court Decision, KG Berlin 4. Strafsenat, Sept 25, 2018, [NLS].
German regulatory classification of cryptocurrencies was established by the German regulator BaFin’s (the Federal Financial Supervisory Authority of Germany) decision in 2013 to classify Bitcoin as a so called “unit of account”, being one subclass of financial instruments. As such, companies and professionals dealing in cryptocurrencies on a professional basis (investment advisory services, exchanges, brokerages, etc.) must obtain the appropriate license. This resulted in basically no such service being available in Germany, except for some rare offerings.
BaFin’s decision has been the main tool to control cryptocurrency markets in Germany until now. However, initial issuance of cryptocurrencies proceeded license-free, and if not combined with such professional service may be deemed to be deposit businesses. In light of this background, a recent criminal court decision has led to a true crypto regulatory earthquake in Germany. Specifically, the higher regional court of Berlin ruled that BaFin exceeded its powers by declaring Bitcoin to be a financial instrument.
Why was this case in a criminal court? This is because operating a business without a required financial regulatory license is a criminal offense under applicable German law. But the construction of criminal offenses by administrative bodies like BaFin is limited by constitutional law. The “rule of certainty of law” as established by Art. 103 of the German Constitution requires that the legislature phrases criminal laws in a way that the addressee of a criminal law can foresee its scope according to its wording. “Formative construction: beyond this limitation by administrative bodies is not allowed. The Berlin court ruled that this is exactly what happened when BaFin stated that cryptocurrencies are financial instruments.
What does this mean for the legal situation for cryptocurrencies in Germany? On the one hand, the German regulator BaFin is not directly bound by the criminal court ruling. Instead, BaFin’s decisions are subject to administrative court rulings. On the other hand, a criminal court explicitly stating that it believes that BaFin went beyond its competence by declaring Bitcoin a financial instrument sends a strong signal to revisit the current token classification.
In short, this decision opens the door to challenge BaFin views in front of the competent administrative courts. It is an opportunity to reconsider which projects should be highly regulated and which ones should be supported by light regulation. This is certainly a topic to be shaped by future regulation based upon socio-political considerations, not yet forming part of traditional regulation.
The discussion surrounding this court ruling should also be used to stress the urgency for European authorities to pursue visibly fraudulent activities in the crypto space. This not only relates to ICO scams, but also more importantly to the growing Ponzi schemes in this space. Healthy crypto markets can only grow if outright fraud leads to immediate consequences. The European crypto community is alarmed by the fact that the noticeable actions by US authorities is leading to a shift of fraudulent activities to Europe, and would very much welcome European authorities to get organised and step up.
Greenwald v. Ripple Labs, 2018 U.S. Dist. LEXIS 177058 * (N.D. Cal., Case №18-cv-04790-PJH, 10/15/2018) [SDP]
American Courts operate within a “federal” system. We have federal courts and state courts. The national and state governments are what are sometimes called “co-equal sovereigns.” Why this civics lesson at the introduction to a summary of a crypto-class-action-case? It turns out that a lot of tactical jockeying in this litigation has involved where cases are litigated — in state court or in federal court. If you are an avid reader of this blog, you will remember that last week’s coverage of Tezos touched on this issue in too.
This particular opinion arises out of the Ripple class action litigation. As the Court puts it, this is a “putative” securities class action where ”plaintiff alleges that Ripple created a digital currency called XRP and “from 2013 to the present, defendants and their affiliates have been engaged in an ongoing scheme to sell XRP to the general public … Plaintiff Greenwald, a resident of Israel, alleges that he “bought and sold XRP in both USD and Bitcoin between December 14, 2017, and May 12, 2018, and suffered losses on those investments as a result of the [defendants’] scheme.” 2018 U.S. Dist LEXIS 177058, *1 (brackets in original; internal citations omitted).
Plaintiff originally filed the lawsuit in state court in California. The conventional wisdom amongst plaintiffs’ lawyers — and I am painting with a broad brush here — is that state courts are better places to sue people. Is that really true? Defense lawyers will tell you that you’re less likely to get “home-towned” in federal court and that the dockets are more consistently reliable, on the other hand, the thing with conventional wisdom is that it is conventional, so sometimes these points are true, sometimes not. But following a typical pattern, the defendant “removed” the case to federal court under something called the Class Action Fairness Act (“CAFA”). The plaintiff filed a motion to moved it back to state court, which is called a motion to “remand”.
The Court granted Plaintiff’s motion and remanded the case to state court. Under U.S. securities laws, Section 22(a) of the Securities Act, to be precise, the Court held that lawsuits that solely allege Securities Act violations cannot be removed under CAFA. One of the things that CAFA does is make it easier to move a case to federal court — it relaxes certain jurisdictional requirements. But the Court was not persuaded, and also said that the fact that the plaintiff wasn’t American “didn’t move the needle.”
What does this mean for crypto-class-action-litigation? If this case represents controlling precedent, cases that solely allege securities law violations aren’t removable to federal court and will be litigated in resolved in state court. Those that include a bucket-load of other claims — state unfair and deceptive practices act claims or common law causes of action — and that satisfy CAFA’s other jurisdictional requirements can be removed.
So there is a tactical choice for a Plaintiff — do you stick to federal securities fraud and keep your spot in state court? Or do you kitchen sink it and either just file in federal court or accept inevitable removal. As a plaintiff, you tend to want to move things towards resolution, as that is when you get paid, so one of the considerations will certainly be likelihood of success of claims and impact on timing.
