Crypto Caselaw Minute #18: 1/10/2019

Government shutdown or not, plaintiffs lawyers haven’t stopped filing new crypto lawsuits. This week we look at three new complaints, one involving lost crypto and a demand for a fork (the software kind), another that says that pre-sold mining hardware contracts were actually securities, and last but not least artificial intelligence on the blockchain (but not so much, it turns out). [As always, Rosario summaries are “NMR” and Palley summaries are “SDP”]

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. (Picture credit: https://pixabay.com/en/gleise-railway-rails-1066111/; CC0 Creative Commons)

Roberts et al. v. Obelisk, Inc., 3:18-cv-02898 (D.S.D.Cal, December 28, 2019) [SDP]

Copy of original state court lawsuit: https://www.scribd.com/document/397202241/Roberts-v-Obelisk

Notice of removal: https://www.scribd.com/document/397202232/Obelisk-Notice-of-Removal;

Are contracts for delivery of mining equipment investment contracts that require state law securities registration? According to plaintiffs in this new lawsuit, the answer is yes. Whether a court agrees with that position remains to be seen of court.

This putative class action was first filed in state court in California and removed to federal court on December 28, 2018. (What’s this whole removal thing about? We’ve written about previously, as in this earlier post — see in particular the discussion Greenwald v. Ripple Labs).

At issue is mining equipment to be used for the Siacoin and Decred cryptocurrencies. Plaintiffs say that the lawsuit “arises out of a scheme by Defendants to raise millions of dollars through the unregistered sale of Mining Appliance Preorders to retail investors” in violation of state consumer protection and securities laws.

According to the lawsuit, defendants sold preorders to the plaintiffs for specialized mining hardware that were advertised as (1) meeting specifications that would allow buyers to make a lot of money once delivered and (2) having a money back guarantee if they weren’t delivered on time or didn’t meet specifications. This all took place against a backdrop of the cryptocurrency bull-market in 2017.

Plaintiffs say that the equipment wasn’t delivered on time and when it finally arrived didn’t meet specifications in that the actual hash rates (the speed at which computations are performed) were too low to allow the buyers to make any money mining. In spite of this, refunds were refused, plaintiffs allege.

The lawsuit alleges that the presale was really an unregistered securities offering under both California and Massachusets law, and that defendants also violated consumer protection laws of both states.

With respect to the securities claim, plaintiffs say they

“provided consideration … in exchange for their Preorders. Preorder purchasers reasonably expected to derive profits from their Preorders of the Mining Appliances, and Defendants themselves have frequently highlighted this profit motive. Finally the development of the Mining Appliances, and the profits that investors expected to derive therefrom, were, and are, based entirely on the technical, managerial, and entrepeneurial efforts of Defendants[.]”

Plaintiffs later explicitly allege that the pre-sale contracts were securities (using the Howey Test) that should have been registered as such and weren’t. (You might wonder — we did — why if this alleges California state court securities law violations they didn’t use the more flexible risk capital test, which is California law. I don’t know either).

Plaintiffs also allege violations of consumer protection laws related to the alleged failure to deliver equipment on time and per specification, or to provide refunds when asked. The Complaint is full of written promises to provide refunds, including a statement by one of the defendant that if they failed to meet a specific deadline they were “legally required to provide a refund.”

If I am handicapping this lawsuit, the consumer protection claims look like they may have more teeth and more likely to survive motion practice. The securities claim looks more vulnerable to attack and is a place where I’d expect defense counsel to focus. It may survive motion to dismiss, but pre-selling mining equipment on its face sounds somewhat far afield from an investment contract).

Kaplan v. CompCoin LLC et al., 1:18-cv-07453 (E.D. NY, December 31, 2019) [NMR]

If you read the Crypto Caselaw Minute regularly you might develop a slightly skewed viewpoint of the blockchain space. I mean, all we talk about in here are lawsuits and governmental actions against crypto companies, but that is not the entirety of this space! One of the great things about the blockchain space is that there are almost no incrementalists. The people building companies in this space almost uniformly dream big, and consequently claim big. Their coin, their technology, it is going to be world changing. That’s great! However, problems can arise when you make promises to people, and they start to give you money based off of those promises, and you don’t really deliver on those promises.

This particular case involves an ICO to fund building out a blockchain for a cryptocurrency that would utilize artificial intelligence to trade on the cryptocurrency holders behalf in the foreign currency markets. It turns out that the AI was never built, and maybe it was never meant to be built. As such, this case alleges violations of federal securities laws, breach of contract, and a bunch of counts based on alleged fraud and misrepresentations on behalf of the defendants. What is sort of strange about this complaint is that it is somewhat light on the evidence presented to show the alleged fraudulent scheme.

According to the complaint, in June of 2015, defendant Alan Friedland registered Compcoin LLC as a company in Florida. Then, in March of 2016, Friedland registers a second company Fintech Investment Group, Inc. in Florida again. Allegedly, shortly after this Friedland “announce[s] his technology and ICO and explained that he was preparing to launch artificial intelligence technology that would automate FOREX trading.”

The plaintiff discovers Compcoins in 2017. Kaplan reads the whitepaper, is intrigued by the technology, and decides to purchase some Compcoins. That purchase is completed through the Compcoin website, which incidentally is the only place Compcoins could be purchased at the time. Okay, so far nothing seems out of the ordinary. A person with interest in the crypto space finds a company, they like what they see, they think the company is doing some cool stuff, and so they put some money into it. What’s the big deal?

Well, the plaintiff made two attempts to sell his coins with no success. The first attempt was when Compcoin, having been listed on a crypto exchange called Nova, hit an all-time high of $12/coin. The plaintiff attempted to sell his coins, but allegedly was told by defendant Friedland that he could not, because of an alleged hack of the exchange. The Nova exchange shuts down, and apparently, additional coins are generated by the Fintech team. For some reason, the price of Compcoins hits another all-time high of $37.03/coin on January 23, 2018. That was the second time that Friedland attempted to sell his coins to no avail. Not being able to sell their coins is usually going to upset people.

Additionally, the plaintiff made at least one inquiry as to why the Compcoin blockchain was behind schedule and had not launched. Allegedly, the reason given was “that the National Futures Association had not yet approved FINTECH and therefore the COMPCOINS could not execute FOREX trades at this time.” That was not true. Fintech had been approved by the NFA on August 19, 2016. If true, that is not a good look.

This case will be interesting to follow to see what additional information comes out in discovery, for example, information concerning the alleged hack. Also, it will be very interesting to see how the defendants respond to the complaint. There are lots of allegations and counts in this lawsuit and, frankly, not a ton of evidence presented when compared to some of the other cases we’ve covered in the CCM.

Fabian v. Nano f/k/a Railblocks f/k/a Hieusys LLC et al., 4:19-cv-00054 (D.N.D.Cal., January 3, 2019) [SDP]

This is version two of a (putative) class action initially filed in federal court in Brooklyn in the fall of 2018 in the name of a different plaintiff (Alex Brola). That lawsuit was dismissed and was just refiled by the same lawyers against the same defendants, but with a different plaintiff. Why would the lawyers dismiss a lawsuit and then refile it somewhere else with a different plaintiff? Gather round children and I’ll tell you a tale.

The new lawsuit. The case involves a cryptocurrency called Nano, a whole bunch of which was stored on an Italian crypto-exchange called BitGrail. Both Nano and BitGrail are defendants, as are a bunch of natural persons. (That is lawyer speak for flesh and blood people, not corporations)

Per the complaint, on February 8, 2018 “over 15 million XRB, bearing a market value of approximately $170 million, supposedly safely stored on BitGrail were ‘lost’.” (Side note, 15 Million XRB are today worth $13,335,000, using a market price of $0.8893, which I found on coinmarketcap.com. The truth is it’s probably less than that, as trying to sell that much of this particular magic bean would probably collapse the market for it.)

Plaintiff says that he had 23,033 XRB worth $260,000 (on February 8) frozen by Defendants and seeks to represent a class of people who used BitGrail to “purchase, invest in, or stake XRB” between January 1, 2015 to March 31, 2018.

The lawsuit contains a long section of factual allegations with a by now predictable collection of in hindsight really regrettable statement on social media by developers and promoters. Plaintiffs use this evidence along with allegations regarding voting power to say that XRB is not a decentralized crypto-currency and that, in fact, “the Nano Defendants wield absolute control over essentially every aspect of XRB and its value[.]” The defendants allegedly used a “Nano Faucet” to maintain high “sell pressure.” When the faucet was turned off, “the price of XRB briefly doubled to nearly $0.17, [but] it was trading on an exchange known as BitGrail that drove the price of XRB up to nearly twelve dollars ($12.00) as of the February 8, 2018 loss.”

According to the lawsuit, “the Nano Defendants created the XRB currency, they directed XRB investors to place their assets at BitGrail (an exchange that they essentially controlled” and when XRB held at BitGrail disappeared they claimed they had no responsibility for the loss. Not so, says the plaintiff, who alleges that they could “create a ‘rescue fork’ to protect PLaintiff’s and the Class’ property rights” but refused to do so because it’ll hurt the value of their own XRB.

Plaintiff says that XRB are unregistered securities under the securities act of 1933 and the Howey Test. The lawsuit also includes a pile of common law claims, from breach of contract to breach of fiduciary duty and some equitable claims.

So, what’s the deal with the dismissed and refiled lawsuit? I have to speculate a little bit here. The first version of this case was filed in federal court in Brooklyn on April 6, 2018 in the name of Alex Brola. The defendants filed a Motion to Dismiss on September 21 and the plaintiff filed a notice of voluntary dismissal on September 28. The case was dismissed by the Court a month later.

This new lawsuit is filed in the name of a different class representative, James Fabian, on the other side of the country, in California federal court. It also names some new defendants, including an Italian BitGrail entity, and has five new causes of action. My guess is that the plaintiff’s lawyers read the motion to dismiss, decided that it contained some decent arguments and decided to find a new class rep and tighten the allegations in their complaint. The motion to dismiss focused on threshold questions about the XRB being a security and whether or not personal jurisdiction could be asserted over a non-US entity. I’ve run a red-line of the two complaints, and it appears that some work was done to try to deal with these arguments in the new lawsuit.

What happens next? It’s reasonable to assume that the next move by defendants will be to dust off that last motion to dismiss and try again in this Court. When that happens, you’ll read about it here!