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Crypto Caselaw Minute #27: March 14, 2019

Stephen Palley
Mar 14, 2019 · 9 min read

This week’s CCM involves old bitcoin disputes, fiduciary shields, and ICO indictments. Also, if you look really closely you will also see the word marmot hidden 15 times in the text. [Palley summaries are “SDP”, This week’s guest post by Preston Byrne is “PJB”]

Disclaimer: These summaries are provided for educational purposes only by Nelson Rosario [twitter: @nelsonmrosario] and Stephen Palley [twitter: @stephendpalley]. Today we welcome guest author Preston Byrne [twitter: @prestonjbyrne] 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:; Pixabay License.)

Srinvasan v. Kenna et al., 2019 U.S. Dist. LEXIS 38834 (N.D. Cal., March 11, 2019) [SDP]

Time isn’t always on your side, as this case demonstrates, and the fact that bitcoin goes up and down in value isn’t going to toll a statute of limitations in the northern district of California apparently.

At issue here are two lawsuits that deal with bitcoin somehow acquired from the Defendant’s company in 2013 or otherwise in its custody. There aren’t a ton of facts in the opinion, which is a mostly clinical analysis of failings in the lawsuit that led to the court’s dismissal, with leave to amend (this means that the plaintiffs can try again).

The Court begins by dismissing the lawsuit because it was filed directly against an individual on a corporate veil piercing theory. Generally speaking, if you create a company and treat it like a real company, it’s viewed as a person in the eyes of the law. If the company breaches a contract or is negligent, the owners of the company can’t be held personally liable in most cases … unless the plaintiff can pierce the corporate veil and (over-simplying a lot) show the court that the company is a sham and that the defendant didn’t treat as anything other than an extension of themselves. Ways that you can show this include failure to maintain corporate records, not having separate bank accounts or have arms-length contractual agreements, and so forth. Basically, you want to avoid treating the corporation likes its the same thing as you. Here the plaintiffs didn’t plead any of the necessary elements of corporate veil piercing so the court said the case shoud be dismissed.

Why sue someone personally instead of their company? One reason might be if you can’t find the company or it’s no longer in existence. Here, plaintiffs may have sued the company’s owner personally because it stopped operating in 2013, and that gets to one of the other issues in this case — statute of limitations. If you want to file a lawsuit against someone, you have to do it within a certain period of time. One of the claims that Plaintiffs made was for conversion — that is, that the defendant stole their bitcoin. But the statute of limitations for conversion in California is three years, according to the opinion. Defendants said that the statute should begin to run in December 2013, when his business shut down. Plaintiffs argued that “[l]ooking at theprice of bitcoin — it is entirely speculative and could have easily dropped to zero numerous times until at least 2016. Until then, [Plaintiffs’] loss was speculative and no cause of action accrued.”

The Court didn’t buy plaintiffs’ argument, and there’s an interesting bit of bitcoin related reasoning here. The court observed that “[c]urrency of any type fluctuates in value. And anticipating a given currency’s future value involves some level of speculation. But that alone does not mean that no harm occurred at the date of taking. Any “manifest and palpable” injury commences the statutory period under California law.”

I can’t say that the Court’s analysis was terribly surprising but it’s interesting that it easily analogized bitcoin to currency in reaching its conclusion, showing once again that when confronted with new technology Courts don’t throw their hands up in despair, but look to existing precedent to reason their way to a conclusion. That’s what happened here.

U.S. v. Ignatov, U.S. v. Ignatova, U.S. v. Scott [PB]

As my friends and usual authors of this column, Palley and Nelson, can attest, long have attorney observers of the cryptocurrency space wondered how the Department of Justice would deal with allegedly fraudulent ICO schemes.

To date, prosecutions of these schemes have been thin on the ground. With the perhaps the exception of U.S. v. Homero Joshua Garza, which concerned a late 2014-early 2015 fraudulent Bitcoin mining Ponzi scheme that also happened to have a “pegged stablecoin” called PayCoin attached to it, the DOJ has been remarkably quiet throughout the crypto boom and a perceived slew of what many practitioners argue are major, multibillion-dollar violations of U.S. securities laws. Where the DOJ has gotten involved, usually the charges are limited to garden-variety wire fraud, as in the Garza case, or money laundering, as with Liberty Reserve.

Rarely, if ever, has the DOJ sought to use securities law to restrain allegedly unlawful ICO conduct. With the OneCoin indictments, those days may be over.

First, a bit of background. The OneCoin scheme is alleged to have started at some point in 2014 amid the great altcoin boom (a boom that also led to, inter alia, Dogecoin, Litecoin, and Ethereum). Among crypto enthusiasts, OneCoin quickly attracted skepticism, for, among other things, the lack of an actual blockchain, the use of MLM-style compensation schemes, and the production of quite obviously fake events on YouTube that made preposterous claims for OneCoin. These claims included a description of the scheme’s founder — a Bulgarian national named Ruja Ignatova — as “the founder of cryptocurrency,” despite appearing to know nothing about cryptography, or a representation that OneCoin’s technology — on a slow-ass blockchain — “can do more transactions than Visa and Mastercard,” which is plainly absurd.

It appears the federal government agrees with most of Cryptoland’s assessment, as the DOJ now alleges that the entire scheme was a massive (~$3 billion) fraud. Without going into too much detail, the indictments give us a pretty good idea of what we might expect to see in future prosecutions for unlawful coin offerings.

The scheme’s attorney was indicted in September with conspiracy to commit money laundering. The complaint and indictment against scheme organizers Ignatov and Ignatova, respectively, each include the expected single count of conspiracy to commit wire fraud, i.e. scheming to obtain “money and property by means of false and fraudulent pretenses, representations, and promises.” Such as that your blockchain has more throughput than Mastercard, for example.

Ignatova herself, however, is charged also with wire fraud, conspiracy to commit money laundering, i.e. concealing and disguising “the nature, location, source, ownership and control of the proceeds of specified unlawful activity,” and (here it is!) securities fraud, on the basis that, “in connection with the purchase and sale of securities,” Ignatova “did use and employ manipulative and deceptive devices and contrivances,” contrary to Rule 10b-5.

This suggests that the DOJ thinks it can convince a judge that an ICO token, at least in the case of OneCoin, is a security, applying the ever-popular four-prong test from SEC v. W.J. Howey Co.. If Ignatova’s case goes to trial, we may expect some useful case law on this point. Note, however, that this does not necessarily mean that the DOJ takes the view that every cryptocurrency system is illegitimate or a security. I draw the reader’s attention to footnote 2 in the complaint against Konstantin Ignatov, which contrasts OneCoin with what the FBI describes as “a legitimate cryptocurrency,” in which “mining… [allows] the cryptocurrency’s nodes to reach a secure, tamper-resistant consensus.” Which is actually a pretty good description of what a cryptocurrency blockchain does.

Lessons here? If the indictment’s allegations are proven to be true, it would mean that OneCoin is among one of the more outrageous, flagrant, and long-running alleged scams in the cryptocurrency business, and only now have the wheels of justice ground their way to an indictment. Yet it still is alleged to have taken in over $3 billion of investors’ money worldwide before those charges became known. Attorneys advising clients on the merits of particular schemes should advise conservatively and confirm that coin offerings have sought to comply with U.S. securities laws, and have fairly and fully disclosed the risks of investment to prospective investors, from day one.

Motto v. Karpeles, 2019 U.S. Dist. LEXIS 39254 (N.D. Il., March 12, 2019). [SDP]

Litigation has a long tail, class actions in particular. This opinion deals with the Mt. Gox cryptocurrency exchange collapse in February 2014, and denies a motion to dismiss filed by the company’s CEO on personal jurisdiction ground.

Mark Karpeles was Mt. Gox’s President and CEO. Per the opinion (which relies on the complaint) As Mt. Gox’s President and CEO, Karpeles “controlled all aspects of Mt. Gox’s business from the ground up,” including software design and operation, public and customer interactions, and accounting practices. However, Karpeles was not responsible for “Mt. Gox’s day-to-day accounting” and did not personally respond to Motto’s and Greene’s communications to Mt. Gox. Karpeles also never made any specific decision to operate in Illinois and was unaware of which or how many Mt. Gox
accounts were associated with Illinois.” (Note — the Court treats all of the allegations in the Complaint as true for purposes of this kind of motion. They haven’t been fully litigated yet, so they are all still allegations and it remains possible that the Plaintiffs will be unable to convince a judge or jury that they are true).

Plaintiffs sued Karpeles for losses that they suffered after the exchange “went dark.” They alleged that he misrepresented the security and stability of the exchange and plead state claims arising out of the exchange’s collapse. It went to bankruptcy in Japan, and Karpeles was arrested by Japanese police and “[d]ue to these criminal proceedings [is] currently prohibited from leaving the country.”

In order to sue someone in a U.S. court, you have to have something called “personal jurisdiction” over them. There are a couple of ways you can get this — actual physical presence is one of them. But if you reach into a state and enter into contracts there, commit torts, or break laws, you can also be subject to personal jurisdiction. This is something that law students study in the first year of law school in civil procedure class and that practicing lawyers who focus on litigation deal with on a fairly regular basis.

Here, Karpeles argued that there were three reasons why there wasn’t personal jurisdiction against him in this case. First, he argued that he never visited Illinois. The Court said that this didn’t matter and that his virtual presence there was sufficient, even if the company hadn’t specifically targeted Illinois. Plaintiffs’ “contacts with the exchange were not random, isolated, or fortuitous, but rather the product of Mt. Gox’s virtual presence in Illinois, as some 7,056, or about 1.5%, of the addresses associated with Mt. Gox accounts came from Illinois.”

Second Karpeles argued it wouldn’t be fair to make defend the lawsuit in Illinois because he can’t leave Japan. The court said it was “unclear” if any other U.S. state had a stronger interest in jurisdiction over these claims that Illinois and that forcing the plaintiffs to litigate their claims would place a significant burden on them. In addition, the Court reasoned that “the burden faced by Karpeles-his confinement to Japan arises from his alleged Mt. Gox-related misconduct.”

Third, Karpeles argued that under something called the “Fiduciary Shield Doctrine” he shouldn’t be subject to personal jurisdiction in Illinois based solely on contacts with Illinois that arose over work for Mt. Gox. This doctrine doesn’t apply, however, where the defendant has “a sufficient interest in the firm’s actions to overcome the fiduciary shield.” Here, the Court reasoned that Karpeles’ ultimate ownership of 88% of Mt. Gox, deprives him of the fiduciary shield where, Plaintiffs allege that he propped up Mt. Gox’s value through intentionally fraudulent representations that he made and directed.”

Bottom line — this lawsuit stays in Illinois federal court and proceed against Mark Karpeles personally. This is a putative class action though and these things take a long time to resolve, so we may be reading opinions in this case for several years to come. Also, if you run a business from outside of the United States and allegedly do harm to people inside the country, the fact that you can’t come home to defend yourself isn’t necessarily a defense.

Law of Cryptocurrency

Summaries of legal opinions about bitcoin, virtual…

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