Crypto Caselaw Minute #49: 8/15/2019
Blockchain health protocols catch the eye of the SEC, moar trademark lawsuits, because, obviously, and a big ole XRP, the standard, update from Marmot Man. This is the Crypto Caselaw Minute.
Disclaimer: Crypto Caselaw Minute is provided for educational purposes only by Nelson Rosario and Stephen Palley. These summaries are not legal advice. They 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”. This week’s marmoty guest post by Preston Byrne is “PJB”. Our Image credit: https://pixabay.com/photos/marmot-glade-summer-animal-3554123/ (Pixabay license).
In the Matter of Simply Vital Health, Inc., SEC Administrative Proceeding File No, 3–19332, Order Instituting Cease and Desist Proceedings [SDP]
Link to order: https://www.sec.gov/litigation/admin/2019/33-10671.pdf
This has been a busy week for the SEC. In addition to an emergency asset freeze against ICO promoter Veritaseum, a Consent Order was entered in a failure to register case against Simply Vital Health, Inc. on August 12. The Order is potentially notable for what it tells us about the SAFT, or Simple Agreement for Future Tokens, which was touted two years ago as a way to do a token offering that kept the tokens outside the scope of US securities laws. Not so much, maybe.
Per the Order, SimplyVital is a Delaware corporation that in 2017 to 2018 told investors and the general public that it was “developing Health Nexus, a blockchain protocol through which healthcare providers could share patient data. SimplyVital announced to investors and in public statements that it was designing Health Nexus to satisfy regulatory requirements unique to sharing data within the health care industry, including, for example, compliance with the Health Insurance Portability and Accountability Act.”
SimplyVital said that to raise money to develop Health Nexus it was going to — wait for it — do a token sale for something called Health Cash (HLTH), which would be used as currency in the “ecosystem.” It planned to issue 200 million HLTH tokens. Before the sale launched, SimplyVital conducted a pre-sale where it offered to enter to Simple Agreements for Future Tokens (“SAFTS”) that would deliver tokens once SimplyVital created them. Pre-sale purchasers had to buy a minimum of 25 Eth worth of tokens which, at the time, was worth about $10,000. By purchasing in the pre-sale they also got a “significant discount” on the price paid by retail shmos in the main sale.
According to the Order, “The SAFTs, which had been prepared by legal counsel retained by SimplyVital in August 2017, stated, among other things, that proceeds being raised in the pre-sale would be used by SimplyVital to fund the development of the Health Nexus platform and blockchain protocol.”
No registration statement was filed. Indeed, the Order pointedly states that “[b]efore it offered and sold HLTH through the SAFTs, SimplyVital did not file a Securities Act registration statement with the Commission covering its offer and sale.” No registrations were filed and the SEC says that no exemptions were available. Also, SimplyVital didn’t take “reasonable steps to verify that purchasers were accredited investors.”
As my friend (and securities lawyer) Gabriel Shapiro has pointed out on twitter “[t]his awkward wording was not necessary and is designed to highlight a view that the tokens, not merely the SAFTs, are securities.” https://twitter.com/lex_node/status/1161724091851821056?s=20. My guess is we are going to see a lot of these agreements attached as lawsuit exhibits in the coming years.
Now here is where it gets really interesting. After SimplyVital finished the pre-sale, it scheduled the main crowdsale. But SEC staff contacted the company and SimplyVital decided not to go through with it. SimplyVital hadn’t created any tokens yet and hadn’t delivered any to the pre-sale SAFT purchasers. It made a public announcement in January that it would not create tokens and would return funds to pre-sale purchasers. As of April 15, 2019, “SimplyVital had returned substantially all of the ETH and USD claimed by investors. This amounts to substantially all of SimplyVital’s assets.”
Because it gave all of the money back and didn’t go through with the public ICO, the SEC didn’t impose a civil penalty but simply entered an order that the company not violate the securities act. So it got off pretty light, all things considered.
Blockchain Luxembourg S.A. et al. v. Paymium SAS et al., Case №18-civ-8612 (S.D.N.Y. Decision and Order August , 2019)[NMR]
Link to order: https://www.scribd.com/document/421304297/paymium
Onomastics is the study of proper names. A proper name is a name for a particular thing, such as, for example, Coca Cola, or Wu Tang Clan, or Boyajian’s Star. Conversely, a common name is a name for a category of things, such as, for example, soda, rappers, and stars. The name of a company is a proper name. Generally, you don’t want the same name as another company, because, you know, people might get confused. Also, if you are a new or smaller company and there is a bigger company out there they might not like you naming yourself after them, and they definitely won’t like it if you name yourself after them and you operate in the same industry. And that, is how we find ourselves here looking at an alleged trademark infringment lawsuit involving Blockchain Luxembourg v. Paymium.
This case was originally filed September 20, 2018, when Blockchain Luxembroug, which you may know as the company simply called Blockchain, sued Paymium for trademark infringement, unfair competition, false advertising, and a smattering of NY state law claims. Now just hold on one second. How does a company named PAYMIUM get sued for trademark infringement by a company known as BLOCKCHAIN. Haha, oh dear reader, because Paymium did an ICO in February of 2018 rebranding themselves as Blockchain.io. Obviously. As the plaintiff’s stated in their amended complaint “Paymium’s use of the [BLOCKCHAIN.IO] Marks is likely to cause consumers mistakenly to believe that the Paymium’s products emanate from or are otherwise associated with [Blockchain].” This is the fundamental allegation in this case, but it is not the primary purpose of the current order handed down by the court. In February of this year, the defendants filed a motion to dismiss the case for failure to state a claim, lack of personal jurisdiction, etc., which brings us to the current order.
First, in their motion the defendants tried to argue that the trademark infringement and unfair competition claims should be thrown out. It should come as no surprise that that was denied. The plaintiffs, Blockchain, managed to sufficiently argue three things that guaranteed the case will continue: 1) their marks were not inherently descriptive, 2) their marks acquired secondary meaning; and 3) the Blockchain marks and Blockchain.io marks were substantially similar enough for the case to proceed.
The plaintiffs also alleged false advertising with respect to statements that Paymium made about being hack free and atomic swaps services they offered, and also that Paymium had registered their offering with the SEC. The Court found that the hack free and atomic swaps statements were not false, so the Court granted that motion.
What about the SEC statement? Here is what Paymium said in advertising materials “Paymium is pleased to announce [its] filing has been accepted and [it is] now registered with the SEC!” What did Paymium file with the SEC? A Form D. As the plaintiffs argued, and as the Court agreed, “[t]he filing of a Form D does mean that a security is ‘registered’ or that it has been in any way scrutinized or approved by the SEC.” Look, puffery and embellishment is in some respects a natural part of life and business. That said, puffery and embellishment about approval from a government entity is a one way ticket to BadTimeVille. In addition, the Court found that Blockchain plausibly alleged injury to their brand based on the false SEC statement. The Court denied this motion meaning the claim stays in the suit.
One bright spot for Paymium in an otherwise grim order is that the motion to dismiss the case against the CEO for lack of personal jurisdiction was granted. Loyal CCM readers are at this point personal jurisdiction gurus, but let’s briefly review. You have to have some connection to the place you’re getting sued in. Brief review done. Here, as the first part of a two part test, the Court applied NY State’s Long Arm Statute to see if they could exercise jurisdiction over the CEO. In the 2nd Circuit, where the Southern District of New York is located, a corporate officer can be held personally liable if they participate or commit a tort, even if they do so as part of their role as a corporate officer. In the Court’s estimation based on the filings from the two parties, the plaintiff’s failed to sufficiently allege that the CEO was involved in the alleged activities claimed in the lawsuit. Instead, the Court felt that the plaintiff made a set of conclusory statements that didn’t met the necessary standard. A small win for the moment as this case continues.
XRP: the more things change, the more they stay the same [PJB]
There’s a great moment in Alan Moore’s Watchmenwhere a pop television philosopher explains the significance of the birth of a new superhero, Dr. Manhattan, to the American public.
Dr. Manhattan, born Dr. Jonathan Osterman, was originally born human. He grew up to be an extremely nerdy, lanky scientist. After being bitten by a radioactive marmot (killed in a freak radiological accident), Osterman was re-born as a nigh-omnipotent being of pure energy capable of experiencing all four spatial and temporal dimensions simultaneously. Oh, and he also has complete command over all existence.
Pretty cool, right? This supposedly led the philosopher to say of Dr. Manhattan that “the superman exists and he is American.” In the television clip, however, he corrects the interviewer by pointing out he actually said “‘God exists and he’s American.’” He continues: “If that statement starts to chill you after a couple of moments’ consideration, then don’t be alarmed. A feeling of intense and crushing religious terror at the concept indicates only that you are still sane.”
https://www.youtube.com/watch?v=s_n_okV8xRU
Those of us with law degrees and experience in securities practice who watched the cryptocurrency space from outside experienced similar feelings in the years between 2015 and 2018. We too questioned our sanity as we watched company after company sell coins into the U.S. market but not treat those coins as securities offerings. Among the companies in relation to which it has been alleged that the coin offerings constitute securities transactions is Ripple Labs.
This week brings us news that, as first reported by CoinDesk (Sorry Mike!), “SEC [Token Framework] Gives Ammo to Lawsuit Claiming XRP is an Unregistered Security.” Much wailing and gnashing of teeth followed on Twitter and in my Signal DMs. The significance of the move is a little overstated on the Internet, so I wanted to break it down briefly here for the readers of this august publication:
1) The plaintiffs already alleged that XRP was an unregistered security in the previous version of their complaint.
They’re not making any allegations that are new.
2) The SEC Framework has no precedential value.
Nor does it feature that heavily in the argument. It appears at paragraph 6 in the summary of the action and a half-dozen times throughout the rest of the pleading. The question before the Court remains whether the sale of XRP satisfies the four prongs of the long-standing test from SEC v. W.J. Howey, Co.and (as the action is brought in California) the alternative four-pronged “risk capital” test from Silver Hills Country Club v. Sobieski specific to California.
While the SEC’s guidance will, undoubtedly, assist the plaintiffs’ case in that the SEC’s conclusions could be seen to support their own, ultimately the SEC’s Framework is of persuasive value and the common-law tests are what must be answered, having due regard for whatever distinctions have been made in similar cases in the past.
3) Ripple has assembled an all-star legal team to defend the action so this is by no means a slam dunk.
Their legal team at Debevoise & Plimpton is led by Mary Jo White, former chairwoman of the Securities and Exchange Commission. Serious business.
4) The best way to think about this is as a sanity check.
The aforementioned quotation from Watchmen is something I have meditated on frequently as an observer of issuer conduct throughout the height of the ICO boom.
Entrepreneurs in the crypto space, or in any space for that matter, are risk-takers and sometimes can be quite cavalier risk-takers. The importance for the legal practitioner advising entrepreneurs on the cutting edge is to be sufficiently confident with one’s handle on the technology or the marketplace that one can ensure that whatever folie a plusieurs has seized the imagination of the market does not also have a firm hold on you.
If you have thought that there is a possibility that what companies like Ripple are doing might be found to constitute the sale of securities, as is alleged in this action, and have been gripped by “a feeling of intense and crushing religious terror” at the implications for these issuers down the line if and when enforcement should come, I have good news for you: this indicates “only that you are still sane” and that you’ve had due regard to the fact that securities enforcement can be a very long game, and that you are in a good position to advise your clients on the risks of operating a cryptocurrency business in the United States.
