Crypto Caselaw Minute #36–5/16/2019
This week we have some updates concerning cases we’ve previously covered, and a new settlement in an administrative proceeding the SEC brought against a prominent blockchain voice. It’s a good week. [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]. These summaries 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/photos/fischbr%C3%B6tchen-fish-herring-food-3313364/; Pixabay License.)
Rensel v. Centra Tech, Inc., 2019 U.S. Dist. LEXIS 79855 (S.D. Fl., 17–24500, 5/13/2019) [SDP]
This case arises out of the Centra Tech initial coin offering (“ICO”) that took place between July 2017 and April 2018. The ICO raised “more than $32 million from thousands of investors.” Things didn’t go so well after that seemingly auspicious beginning. Three founders are the subject of both an SEC enforcement action and are being criminally prosecuted for fraud in federal court in Manhattan. This particular order grants a motion to dismiss by DJ Khaled, Floyd Maywether, and Centra Tech CTO Steven Sykes.
As readers may recall, the Centra Tech founders used a marketing campaign in which they claimed they had created a first of its kind crypto debit card that worked with more than eight “major cryptocurrency blockchain assets” and that it would be accepted “anywhere that accepted Visa and Mastercard.” They also had the requisite whitepaper which explained why buying the tokens would be profitable. They also created fake executives with storied backstories and even fake LinkedIn profiles, and used those fake bios in investor presentations.
Centra Tech also paid celebrities to promote the token sale, including Floyd Maywether and D.J. Khaled. They both used social media to promote Centra Tech. Maywether, for example, “posted a tweet with a picture of himself holding a Centra Tech debit card and captioned the picture: ‘Spending bitcoins Ethereum and other types of cryptocurrency in Beverly Hills[.]’” Khlaed engaged in similar social media stylings. Both Khaled and Maywether have since agreed to consent orders with the SEC for violating anti-touting rules which say, in essence, that if you’re being paid to promote a security you have to disclose that, and have paid fines.
Plaintiffs in this class filed a securities fraud class action against the Centra Token founders and Maywether and Khaled and also against Centra Tech’s CTO Steven Sykes. These defendants filed motions to dismiss, which the Court granted.
The parties did not dispute that the CTR tokens were unregistered securities sold in interstate commerce. At issue is these defendants “sold or offered to sell securities.”
As to Maywhether, the Court reasoned that with respect to Count I, which alleged unlawful sale of an unregistered security under Section 12(a)(1) of the Securities Act, “[t]he Plaintiff’s complaint fails to establish that Mayweather “successfully solicited” the Plaintiffs to purchase CTR Tokens. The allegations against Mayweather establish that he posted two tweets from his Twitter account related to CTR Tokens. One of the posts urges his followers to “get yours before they sell out, I got mine.” This is the closest thing to “solicitation” in the complaint. However, there are no allegations that this was a successful solicitation, that Mayweather had any contact with Plaintiffs, or that Plaintiffs even saw the posts.” With respect to Count III, which alleged fraud under Section 10(b) of the Exchange Act, the Court similarly held that there was no reliance and no fraud. In addition, the Court held that a theory that his fraud created the market also failed because there was evidence that the market for the tokens already existed before Maywhether was involved.
The Court applied a similar analysis to DJ Khaled. First, “Plaintiffs cannot assert that Khaled “successfully solicited” the Plaintiffs to purchase CTR Tokens.” Second, there is no evidence that Plaintiffs relied on Khaled’s tweets, and (like Maywether) no evidence that his alleged fraud “created the market”, which already existed prior to his social media posts. As a result, the claims against Khaled were also dismissed.
Centra Tech CTO Sykes also a filed a motion to dismiss. “He was responsible for the content and maintenance of Centra Tech’s website, including the website’s “customer experience.” (Id.) Sykes’s motion to dismiss argues that his involvement with Centra Tech’s website does not make him a seller of securities under Section 12(a)(1) of the Securities Act. In response, the Plaintiffs argue that “any and all solicitations for the purchase of CTR Tokens contained on the Centra Tech website are equally attributable to him and hence, he was a ‘seller’ of unregistered securities.”
The Court reasoned that general involvement in a company as a CTO does not make you a seller of securities and “does not establish that he had any contact with investors or in any way solicited investors to purchase CTR Tokens.” Similarly, “The allegations against Sykes are based on his involvement with the website. The Complaint, however, is devoid of any specificity with regard to the content of the website, when the website was launched, the alleged misstatements on the website, who determined the content on the website, and if the Plaintiffs ever even visited the website.” For these reasons, the Court dismissed all claims against the CTO.
Finally, the Court dismissed claims against Centra Tech’s Director of PR. As with the other defendants, there was no evidence that he was involved in the sale of securities and that any plaintiff read or relied upon his statements, which included answering questions in public forums and posting press releases.
Bottom line — even those these defendants were involved in a token sale that turned out to be a scam, their conduct (as alleged in the class action complaint) did not make them liable for sale of unregistered securities securities or securities fraud.
In the matter of NextBlock Global Ltd. and Alex Tapscott, Administrative Proceeding File №3–19164, Issued 5/13/2019 [NMR]
This order concerns the settlement of an administrative proceeding that the SEC brought against NextBlock Global Ltd. and Alex Tapscott. If you are familiar with the world of blockchain thought leadership then you should be familiar with the name Tapscott, that’s because Alex Tapscott is Don Tapscott’s son and together they wrote a book called Blockchain Revolution published in 2016. The Tapscotts are prolific and prominent influencers in the corporate blockchain world, so this settlement is certainly notable because of the players involved.
NextBlock was a blockchain focused investment fund that was founded in Canada in June of 2017 by Tapscott (Alex) and three others. NextBlock began fundraising taking in investments in Canada, the US, and elsewhere. In fact, NextBlock filed for a Form D exemption with the SEC on August 11, 2017. Some may recall what happened next.
It turned out that as part of their fundraising efforts the NextBlock team claimed that they had four prominent blockchain advisors as part of their team. Spoiler alert, said advisors were not in fact advisors for NextBlock. Oops. News of this came out in November of 2017, which led to uhh, interesting discussions on CryptoTwitter. This news broke in the middle of a second fundraising round for NextBlock. To the teams credit they shut down the fundraising round and began the process of winding up the company in Canada and returning investor funds.
What exactly did NextBlock do that caused the SEC to initiate the proceedings? Well, you can’t claim you have advisors that aren’t actually advisors, because that is a “[violation] of Section 17(a)(2) of the Securities Act, which prohibits any person in the offer or sale of securities from obtaining money or property by means of any untrue statement of material fact or any omission to state a material fact necessary in order to make the statements made not misleading.” With the issuing of this order the SEC, NextBlock, and Tapscott all agree that these violations occurred, and Tapscott will pay a $25k civil fine.
One thing that is worth keeping in mind is that (in the case of any order like this one) investors could still theoretically bring a lawsuit against NextBlock and Tapscott “based on substantially the same facts as alleged in the Order instituted by the Commission in this proceeding.” According to findings in a parallel proceeding by Canadian securities regulators, this was not an unprofitable venture for investors, so that may be unlikely in this case. Still, it’s worth noting that if you violate securities laws by making material misstatements of fact you can still be subject to an SEC smack down even if your investors didn’t lose any money.
Garrison et al. v. Ringgold et al., 19-cv-244-GPC (SD Cal. filed adsfafdsfa)[NMR]
We have a new order in the Garrison v. Ringgold case. If you do not recall, this case was covered in the Crypto Caselaw Minute back in February where I revealed that I was a Grandparent Maximalist. That is still true. My grandparent maximalism that is. Okay, what are we talking about? A yes, a new order from the judge in the case.
A quick refresher of some of the relevant allegations in this case. In no particular order, the Garrisons allegedly lost over $800k that they had invested with Ringgold in his venture based on promises and representations he made to them. After the lawsuit was filed the defendants understandably filed a motion to dismiss the case, the plaintiffs filed an opposition, and the defendants filed a reply. The judge has now ruled on the motion to dismiss and grants it in part and denies it in part. Why?
A defendant may argue to a court that what they are being sued for in essence doesn’t make sense, because they claim that the plaintiffs failed state adequate reasons for the suit, or the plaintiffs didn’t meet the particular requirements under their legal theory of the case.
Here, the Court dismissed the parts of the motion to dismiss which claimed that the plaintiffs didn’t supply adequate factual allegations concerning the alleged securities violations as well as the financial abuse of an elder allegation. The Court also ruled on whether the plaintiffs failed to join a necessary party to the lawsuit in this case to enable complete relief. Who is the necessary party you ask? BitcoNNNNNNNNNNEEEEECCCTTTTTT!
Basically, the defendants tried to claim that because Bitconnect was not a party to the lawsuit the lawsuit should be dismissed. The Court was having none of that and dismissed that part of the motion as well. So, what did the Court grant? Well, the Court, in accordance with established federal law, on its own has decided that the plaintiffs may amend their initial complaint against the defendants. The plaintiffs did not seek leave to amend, but now they may if they wish to change the lawsuit. This is not the end of this lawsuit.
