Crypto Caselaw Minute #42–6/27/19
So. Much. Crypto. Litigation. It was hard to pick just three cases this week but we winnowed it down just for you and herewith and forwith give you the tl;dr on what we think is the first crypto class action certification opinion, a perfunctory gloss on Bittrex’s arbitration clauses (enforceable), and yet ANOTHER bitcoin escrow kerfuffle.
Disclaimer: These summaries are provided for educational purposes only by Nelson Rosario and Stephen Palley. 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.
(As always, Rosario summaries are “NMR” and Palley summaries are “SDP”. Image credit: Luigi Anzivino, https://www.flickr.com/photos/ilmungo/74205671 (license CC BY-SA 2.0))
Audet v. Fraser, 2019 U.S.Dist. LEXIS 04195 (D.Conn., 3:16-cv-0940, 6/21/19) [SDP]
As we’ve pointed out many times in these pages, just because you file a class action lawsuit doesn’t mean that it’s actually a class action. All class actions are “putative”, a fancy way of saying so-called, unless and until a judge decides to certify it. That just happened in the long running GAW Miners litigation pending in federal court in Connecticut, in what may be the first class certification in a case involving cryptocurrency.
The case in a nutshell involves “Plaintiffs … who invested in products that ostensibly allowed them to share in the profits generated by ‘mining” … digital currency. They are suing two companies who sold them these products and an individual who allegedly controlled these companies” claiming a variety of fraud claims, in vioation of federal and state securities laws and common law.
Plaintiffs initially sued Homero Joshua Garza, Stuart Fraser, GAW Miners LLC and ZenMiner LLC. The companies did not answer the Complaint and Plaintiffs took a judgment against them. The Court says that Fraser says Garza was dimissed after he agreed to cooperate with plaintiffs. It also says that Fraser is the only remaining active defedant.
According to the opinion, Garza met Fraser in 2003. Fraser was vice-chair of the investment bank Cantor Fitzgerald and invested in a number of Garza’s business ventures. In 2014, Garza incorporated GAW Miners and served as its CEO. Fraser invested in GAW and “served as ‘the Board’”. Garza a few months later incorporated ZenMiner, which was controlled by Garza and Fraser. (One assumes that Fraser remains a viable defendant from the plaintiffs’ persepective because as the vice-chair of an investment bank they imagine he has resources to pay a judgment).
GAW was formed to buy mining equipment from oversease and resell it to customers. In 2014 it “began selling Hardware-Hosted Mining.” Customers who bought this “were told that GAW Miners would host computer hardware in its own datacenter, but allow customers and access and control their equipment” using remote access software. They then began offering “Cloud-Hosting Mining”, a similar concept. Customers were told they could end hosted service any time they wanted and get their equipment mailed to them. Plaintiffs say that in reality this was all a bunch of b.s. and defedants didn’t actually have enough equipment to return to them and in fact that this was really a Ponzi scheme, where money from new customers was used to pay returns to existing customers.
In response to customers complaining they couldn’t see an increase in mining pool power, the defedants “offered customers the ability to convert their Cloud-hosted machines into another product … called Hashlets.” These were supposed to represent “a right to profit from a slice of the computing power owned by the Companies” with no right to physical equipment. When hashlets didn’t generate sufficient revenue, GAW said it was going to launch a new type of cryptocurrency called Paycoin and develop a marketplace for it called Paybase. There’s more complication described in the opinion but the bottom line is that if all of this sounds like three card monte to you you won’t be suprirsed that the SEC and DOJ thought so too. Garza and GAW Miners wer sued by the SEC for securities fraud and he pleaded guilty to wire fraud on July 20, 2017.
With that background in mind, on to this opinion, which grants class action status to the complaint, defining the class as “All persons or entities who, between August 1, 2014 and January 19, 2015, (1) purchased Hashlets, Hashpoints, HashStakers, or Paycoin; or (2) aquired Hashlets, Hashpoints, Hashstakers or Paycoin by converting ugrading, or exchanging other products sold by the Company.”
The Court goes through a lengthy analysis of the procedural requirements for the procedural requirements of a class aciton — commonality, adequacy, typicality, numerosity, predominance and superiority, for you civil procedure buffs.
While the burden of proof for each element is on the plaintiff the court notes that where there is a doubt about certifying a securities fraud class actio, “the court should err in favor of allowing the class to go forward.” While we don’t predict the future here at crypto caselaw minute, I for one would not be surprised this opinion and that particular citation referenced in other crypto/ICO securities class action opinions in the future.
Also of note if you are following other crypto class actions — inclding ones where people have made money — the Court says the class needn’t exclude people who broke even or profited. “A plaintiff suffers an injury in a securities fraud case when she changes her position — such as by buying or selling — as a result of a material misrepresentation.”
Class certification is a big hurdle of course, but this case is certainly not over yet. Note that this case was filed three years ago on June 16, 2016. These things take a LONG time to resolve. We will keep you updated as the case progresses.
Ventoso v. Shihara et al., 2019 U.S. Dist. LEXIS 107101 (S.D.N.Y., 19 Civ. 3589, 6/26/2019) [SDP]
Cryptocurrency exchange Bittrex’s arbitration clause is at issue in this new opinion from federal court in New York City.
The plaintiff is a New York resident with a Bittrex account. The lawsuit names Bittrex CEO Bill Shihara, along with the corporation as defendants. (Presumably, Defendants will ask for dismissal of Mr. Shihara during the arbitration. In most cases like this one a corporate officer is protected from personal liability by the corporate shield).
According to the opinion, when plaintiff registered, she agreed to terms of service that included an arbitration clause. The first page of the terms stated in all capital letters that the Arbitration clause contained within in it “governs resolution of certain disputes and waives any right to trial by jury or to participate in a class action.”
Plaintiff alleges that she deposited $120,000 with Bittrex in August 2018 and that “Bittrex suspended her account and attempted to extort her by withholding the funds she had in her account unless she” signed an agreement releasing her rights to sue Bittrex and that it did not release her funds until November 18, 2019. Bittrex says that it isn’t true and that the plaintiff refused to provide evidence of source of funds as required by N.Y. state and U.S. federal law.
Defendants moved to compel arbitration or transfer the case to federal court in Seattle. Plaintiff didn’t respond to the motion which (unsurprisingly) the Court granted. Even though there was no response, the Court analysed the enforceability of the arbitration clause and found that the clickwrap agreement here was enforceable: “when [Plaintiff] originally signed up for her user account, she checked a box to indicated that she accepted the Terms of Service, including the mandatory arbitration clause.” Also, whether the dispute here is covered by the arbitration clause is ultimately to be determined by the arbitrator.
One imagines an uphill battle convincing an arbitrator that (if we assume Bittrex’s argument is correct) that requiring documentation of source of funds is somehow unlawful, if required by state and federal law. One also wonders what the plaintiff’s damages calculation will be. Given the fact that this will be resolved in arbitration, which will be private, that analysis may never see the light of day. With that said, this case joins a number of others that confirm the enforceability of arbitration clause in cryptocurrency currency exchange terms of service.
Benthos Master Fund, Ltd. v. Etra, 2019 U.S. Dist. LEXIS 104492 (S.D.N.Y. decided June 20, 2019)[NMR]
Do you ever wonder how much over the counter trading in cryptocurrency occurs? Like, is there a giant shadow market out there beyond the reach of exchanges where deals are done via handshakes and escrow accounts? Well, if you’ve had those thoughts this case is further evidence for ya.
This particular entry in our ongoing series of Escrow Gone Wild™ starts out simple enough. Benthos Master Fund is a crypto investment firm based in California. Seeking to secure a heavy bag they reached out to New York based attorney Aaron Etra who would act as the escrow agent for the purchase of bitcoin from a third party. Seems normal enough.
Benthos entered into an agreement, the Bitcoin Agreement, with a non-party to this arbitration proceeding named Valkyrie Group LLC for the purchase of 10,000 bitcoin. The new business relationship would begin with an initial purchase of $5,000,000 worth of bitcoin. Valkyrie was run by a father-son team that claimed to be able to locate third parties willing to sell large quantities of bitcoin. The Bitcoin Agreement referenced an Escrow Agreement that indicated Etra would use his trust account and hold the $5 mil buckaroos while Valkyrie rustled up some sellers. Mkay, so far so good. August 6, 2018, Benthos wires $5 mil to Etra’s trust account. That started a timer in the agreement that in fifteen days the bitcoin had to be delivered or the money returned. Here’s what happened next.
“On August 7, 2018, Etra wired $3,000,000.00 to an unknown account, purportedly for the purpose of obtaining Bitcoin. (Id. at 17.) Shortly thereafter, Respondent Tracy Evans informed Benthos that the Bitcoin could not be obtained without releasing an additional $2,850,000.000, in additional to the first $3,000,000.00 that had already been released.3 (Id. at 18.) Benthos declined to send the additional $850,000.00. (Id.)
On August 24, 2018, Etra wired an additional $1,600,000.00 from the IOLA account to another unknown account. (Id. at 23.) On August 28, 2018, Benthos demanded the return of its $5,000,000.00”
What went wrong? Well, allegedly, Valkyrie was going to buy the bitcoin from a Russian oligarch, but said oligarch had the bitcoin in a storage facility in Dubai and couldn’t release less than 1,000 bitcoin in a single transaction, and so an additional $850k was needed to release 1,000 bitcoin. You know, just another day in crypto.
How did this end up in arbitration and federal court? Well, the agreements were subject to arbitration, but Benthos filed a motion in federal court for preliminary injunctive relief in aid of arbitration basically asking the court to force Etra et al. to stop moving money out of the trust account, produce communications between Etra with all the parties involved, and produce information about the storage facility and the other parties involved.
Over the final few months of 2018 there was some back and forth, and additional filings, after the Court ordered Etra to produce the documents and information. Benthos repeatedly felt as though Etra was not forthcoming and complying with the Court’s orders. Etra thought otherwise. Eventually, Benthos files a motion to hold Etra in contempt of court and sought to have him sanctioned. That brings us to the present day and this particular order.
Contempt of court just means you haven’t complied with a court order. Here, the Court recites the standard in it’s jurisdiction “[t]o hold a party in civil contempt, it must be shown by clear and convincing evidence that the alleged contemnor violated a “clear and unambiguous order of the court” and that “the contemnor was not reasonably diligent in attempting to comply.”” However, as the Court notes, just because you don’t meet the strict requirements of an order does not automatically mean you are in contempt. Here, Etra provided 545 pages of communications and submitted an affidavit that those were the totality of communications he had in his possession. He also returned the $400k left in his trust account. Those actions were good enough for the judge to conclude that Etra did not deliberately disregard the order, and therefore the judge denied the motion for contempt.
As for the sanctions? Well, that was denied as well, but on procedural grounds, which is not something any lawyer wants to see. Benthos was seeking sanctions, because allegedly at one point early on Etra lied in court about whether he was represented by an attorney, and falsely asserted that Benthos wanted the bitcoin transaction to be consummated and that justified his actions. Benthos thought this met the requirements that allow a “court to sanction a party if the court determines that the party has violated Rule 11(b) by making false, misleading, improper, or frivolous representations to the court.” Seems like that would suffice, but you know, there’s rules about the rules. Under the Federal Rules of Civil Procedure “[a] motion for sanctions must be made separately from any other motion and must describe the specific conduct that allegedly violates Rule 11(b).” Fed. R. Civ. P. 11(c)(2).”” Benthos included their sanctions request in the contempt motion. Denied.
