Crypto Caselaw Minute #16–12/27/2018
This week’s CCM looks at just what passes for an asset these days, takes a look at when escrow services go wrong, and we are lucky to have a guest post from attorney Andrés Chomczyk who breaks down a recent criminal case in Argentina concerning the theft of ether from an exchange. (As always, Rosario summaries are “NMR” and Palley summaries are “SDP”, and for this week our guest summary is labeled “ACH.”)
Disclaimer: These summaries are provided for educational purposes only by Nelson Rosario [twitter: @nelsonmrosario] and Stephen Palley [twitter: @stephendpalley]. They are not legal advice. These are our opinions only, aren’t authorized by any past, present or future client or employer. Also we might change our minds. We contain multitudes.
Federal Trade Commission v. Apex Capital Group, LLC (C.D. Ca. 2:18-cv-09573, 12/18/2018) [NMR]
Link to order: https://scholar.google.com/scholar_case?case=13227951917836845964
A common theme you encounter in the cryptocurrency world is that this technology exists in a “Wild West” devoid of regulation. That is not really true. In fact, cryptocurrency is subject to plenty of regulation, and has drawn the attention of many different regulators. One such regulator that is not commonly discussed is the Federal Trade Commission. The Commission is primarily focused on protecting consumers by policing anticompetitive, deceptive, and unfair business practices.
This case involves an FTC action to stop Apex Capital Group, and affiliated companies and individuals, from operating an online enterprise that allegedly tricked consumer into free trials that weren’t free, buying products without the true cost disclosed, and other nefarious activities. The FTC filed for a permanent injunction on November 14, 2018, to shut down Apex’s business. After the court determined that a temporary restraining order was proper the FTC moved for a stipulated preliminary injunction with asset freeze, receiver, and other equitable relief. This means that Apex is going to be shut down, their assets need to be accounted for, they need to be stopped from destroying documents, and the court needs to preserve its ability to award effective final relief . So, what does this have to do with cryptocurrency?
Well, the FTC knows that people have tried, and continue to try, to hide assets in cryptocurrency. This case is an example of that cognizance as there are multiple references to cryptocurrency in the order. Specifically, the FTC has structured their order such that any cryptocurrency held by the defendants are considered assets that need to be accounted for. Yes, but what does that mean?
Let’s start with a definition. In the order assets are defined as: “any legal or equitable interest in, right to, or claim to, any property, wherever located and by whomever held, including any digital assets such as cryptocurrencies.” (emphasis added). As such, under the header “Duties of Asset Holders and Other Third Parties” in the order cryptocurrency exchanges or service providers are called out as types of assets holders and third parties that are required to comply with the order. Any one of these businesses that receives notice of this proceeding are required to turn over any:
…cryptographic hash value, time stamp, transaction data, public addresses or other information sufficient to identify, locate, and track cryptocurrency in any blockchain or distributed ledger technology system that is belonging to, for the use or benefit of, under the control of, or subject to access by any Defendant…
Practically speaking, if an exchange receives notice of this order from the FTC, and the exchange determines that one of the defendants had an account with them they are going to have to produce their records related to that defendant. So, even though the defendants were not engaged in some sort of crypto scam their actions may have consequences for crypto companies. The Wild West these parts are not.
Symphony FS, LTD v. Thompson, 2018 U.S. Dist. LEXIS 21464 (E.D. Pa. 5:18-cv-3904, 12/20/2018) [SDP]
Link to opinion: https://www.scribd.com/document/396406135/Symphony-Opinion
This case involves a dispute over the use of escrowed funds to purchase bitcoin. It also shows the peril of sending money for bitcoin to an escrow agent who doesn’t actually hold the crypto.
Here’s the gist: Plaintiff (“Symphony”) says that it wired $4 million to defendant to buy bitcoin and instead bought bitcoin for itself. Defendant (“Thompson”) says the money was stolen by the seller’s escrow agent. Plaintiff filed a lawsuit and sought a temporary restraining order and a preliminary injunction seeking an asset freeze. The Court said no.
The Plaintiff is an Irish company that, among other things, engages in cryptocurrency trading. Thompson owns a company called Volantis Escrow (“Volantis”) that allegedly “focuses on bitcoin escrow services.”
In July 2018, Symphony and Volantis signed an Escrow Services Agreement (“ESA”) by which “Volantis would hold and exchange assets for Symphony, including converting fiat currency into cryptocurrency.” The idea was that Volantis would purchase north of 5,000 bitcoin for Symphony, in tranches. The ESA also says that transactions would be on a “bilateral basis”, which Symphony’s CEO understood this to mean that Symphony would only purchase bitcoin directly from Volantis, not an original seller.
For an initial transaction, Symphony sent 3,303,500 Euros to Volantis Escrow for the purchase of 500 “miner bitcoins.” Instead of acting as an escrow agent for both buyer and seller, Thompson used a double-escrow structure, involving two escrow agents: “one accepts the purchase money from the buyer and the other accepts the bitcoin from the seller. Once the parties establish control over the assets and verify that they have been transferred, the escrow agents distribute the assets.”
Thompson claims that after converting the Euros to dollars he sent them to the seller’s “escrow agent”, which then “absconded with the funds, with the assistance of others.” Symphony says it assumed that Thompson had “operational control” over the 500 bitcoin before it sent the money and would never have entered the ESA or sent the money if it had thought otherwise.
Plaintiff filed an arbitration claim against Volantis but when it could not find LLC registration for Volantis on file with the Delaware Secretary of State, it sued Thompson. Thompson explained that the lack of a separate LLC filing is a result of Volantis being something called a series LLC, which doesn’t require separate filings for each LLC. The Court said that this is a fact question precluding relief on plaintiff’s claim for injunctive relief.
This is a really LONG opinion that goes pretty deep into the weeds on the legal theories Plaintiff pleaded and the bottom line is that the Court wasn’t convinced that Plaintiff satisfied the standard for getting injunctive relief. Also, the request for an asset freeze was denied. Though it doesn’t seem to stop people from asking, those are really, really hard to get if you’re a private plaintiff.
What’s the takeaway from this case? I’d say that there are two big ones. First, just because you can file a lawsuit that makes things sound bad doesn’t mean that a court after briefing and careful analysis is going to go along with your theory. Second, bitcoin escrow agreements are fraught with peril. I would personally be exceedingly reluctant to send money to anyone I hadn’t fully vetted and who hadn’t proved to me that they controlled the bitcoin that they were promising to send. The more escrow agents you have involved, the more chance there is for someone to run off with your cheddar. And it’s not like you can run to the bitcoin help desk to force ’em to send the crypto.
P., H. M. s/ defraudación informática en concurso real con violación de secretos y de la privacidad, (Third Division of the Criminal Court the Province of Chaco, Argentina, 11/21/2018) [ACH]
Link to opinion: http://www.fintechblog.org/wp-content/uploads/2018/11/Sentencia-126_5-defraudaci%C3%B3n-inform%C3%A1tica.pdf
On November 21st, 2018 the third division of the Criminal Court of the Province of Chaco, Republic of Argentina (the “Court”) issued the verdict in the case “P., H. M. s/ defraudación informática en concurso real con violación de secretos y de la privacidad”. This is the first criminal sentence issued in Argentina regarding cryptocurrency theft.
The events that motivated the case are as follows. Between the 14th and 16th of December in 2017, Mr. H. M. P. conducted a cyber attack on the exchange Mercury Cash. As part of the attack H.M.P. managed to access the Company’s systems and carry out ether transfers to accounts he kept on other platforms, and later transferred them to a wallet on his phone. The attacker was identified by the exchange through the IP addresses of the devices used to gain access to the system. Moreover, the attacker was able to be identified thanks to the collaboration between the different exchanges involved, since most of the addresses where the ethers were sent belonged to other exchanges. It is worth noting that the hacked exchange collaborated with the Argentine authorities and provided full disclosure regarding how they operated, what security measures were in place, and provided all information necessary to convince the judge of the identity of the hacker in order to obtain a search warrant of his house and personal devices.
Considering the facts, the accused was brought up on charges of cyber fraud and violation of secrets and privacy (section 173 subsection 16 and section 153 subsection 2nd), after a request for an abbreviated trial, the defendant admitted his culpability concerning the facts. As part of the trial the Court considerd the fact that the accused defrauded the owners of Mercury Cash through the cyber attack, and generated the loss of a considerable sum of ethers. At the same time, the Court considered that it was appropriate to impose a heavier penalty than normal since the fraud had fallen on a financial services provider. In this regard, the Court concluded that Mercury Cash, a cryptocurrency exchange, was the same as a financial institution regulated by the Argentine Central Bank. This conclusion is in clear contradiction of the official statement issued by the Argentine Central Bank back in 2014 where they indicated that cryptocurrencies were not under its reach to be regulated.
