11 crypto firms sued illegal ICOs
Cryptocurrencies,  People,  Regulation

Crypto faces ‘The man who took on Wall Street’

On the day before the statute of limitations expired, the lawyer who extracted $25 billion from banks over the subprime mortgage crisis sued 11 cryptocurrency firms for holding illegal ICOs

Eleven cryptocurrency issuers and exchanges including Tron, Block.one, and Binance were hit with class action lawsuits over their initial coin offerings last week.

The cases were filed on April 3, the last day possible under the statute of limitations. That was a year to the day after the U.S. Securities and Exchange Commission issued its long-awaited “plain English” guidance on what makes an ICO a securities sale.

11 crypto firms sued illegal ICOs
Attorney Philippe Selendy—”The man who took on Wall Street”—is going after ICOs (Photo: Selendy & Gay).

Ominously, they were filed by a group of lawyers led by Philippe Selendy, who the Financial Times called “The man who took on Wall Street” after he forced 16 major banks including Citigroup, Goldman Sachs, and JPMorgan Chase to pay $25 billion for their part in the subprime mortgage crisis that sparked the Great Recession of 2007.

The details of the 11 current lawsuits differ, but all revolve around one core allegation: the token-issuers held and the exchanges promoted illegal, unregistered securities offerings. 

In doing this, they “failed to comply with federal and state securities laws intended to protect investors from unscrupulous behavior in the rush to capitalize on this enthusiasm,” said Kyle Roche, a lead partner on the cases, in a release.

It’s not just the companies that are being sued. 

The firms Roche Cyrulnik Freedman and Selendy & Gay are also going after top executives individually on behalf of their clients and the class of investors they represent. These include blockchain developer Tron’s Justin Sun, EOS-issuer Block.one’s CEO Brendan Blumer, and Changpeng “CZ” Zhao, CEO of leading cryptocurrency exchange Binance.

The big gun

On Sept. 2, 2011, Selendy filed a lawsuit on behalf of the U.S. Federal Housing Finance Authority (FHFA) for the losses taxpayers suffered when borrowers defaulted on so-called subprime mortgages they could not possibly afford, spurring one of the worst economic downturns in U.S. history.

No one gave Selendy and his boutique litigation firm Quinn Emanuel Urquhart & Sullivan much chance against the combined might of financial giants that also included international financial institutions such as Deutsche Bank, HSBC, Nomura, Credit Suisse, and Société Générale.

Five years later Selendy had beaten them all. In total, he claims to have recovered a total of $35 billion for clients over the last decade.

11 crypto firms sued illegal ICOs
Attorney Jason Gottlieb (Photo: Jason Gottlieb)

Despite that pedigree, Kyle Roche and Velvel Freedman of Roche Cyrulnik Freedman are more familiar to crypto insiders because of their lawsuits seeking $5 billion and half of the Bitcoin intellectual property from self-proclaimed Satoshi Nakamoto Craig Wright, and the $1.4 trillion class action accusing Tether and Bitfinex of causing the entire Crypto Winter. 

That is why the cryptocurrency industry is “talking about these suits as being Roche Cyrulnik suits,” said Jason Gottlieb, a partner at New York-based law firm Morrison Cohen LLP, and principal author of its Cryptocurrency Litigation Tracker.

“To me, the stronger sign here, the more interesting signal, is that they’re all co-counseled by Philippe Selendy,” Gottlieb told Modern Consensus. “He’s a really serious player… a top notch, big time legal mind,” he said.

Gottlieb, who has represented both defendants and plaintiffs in class action lawsuits as well as defending cryptocurrency firms against the SEC and other agencies’ enforcement actions, added that Selendy’s involvement explains why the 11 suit were such “very well written, very professional complaints.”

Betrayal of trust

“The crypto-asset market has exploded in the last few years with ICOs that make great promises but deny investors critical information on the securities sold,” Selendy said in an April 6 release

“Not unlike the mortgage crisis that led to the Great Recession, the alleged pattern of misconduct by exchanges and issuers yielded billions in profits for wrongdoers through a basic betrayal of public trust,” he said. “The lawsuits we filed seek to restore integrity and transparency to these new financial markets.” 

11 crypto firms sued illegal ICOs
Kyle Roche (Photo: Roche Cyrulnik Freedman)

Kyle Roche said that one common theme runs through all 11 cases: dishonesty about the status of the digital tokens on offer. Regardless of whether they were presented as cryptocurrencies or utility tokens, the success of Bitcoin led to a “growing enthusiasm” that Roche argued had “spilled over into the market for initial coin offerings,”

As a result, he said, investors flocked, hoping to get in on the next Bitcoin. “The cases allege that exchanges and issuers failed to comply with federal and state securities laws intended to protect investors from unscrupulous behavior in the rush to capitalize on this enthusiasm,” Roche added.

While Gottlieb was at pains to point out that each of the suits is based on a different set of facts, that common theme of misleading investors can be seen in the various complaints.

One avenue of attack Selendy and the other attorneys did not take is accusing the token issuers and exchanges of fraud. That “is strategically sensible because it makes it easier to survive a motion to dismiss,” Gottlieb said.

Under the wire

The timing of the suits and the decision to file all 11 at once begs the question: why now?    

Well, there’s a simple answer: April 3 of this year was the last possible day to file under the statute of limitations. 

Specifically, it is one year to the day after the SEC released its “plain English” guidance on what makes an ICO a security. And, based on an assertion common to all the cases, that made it the deadline.

“Generally, in cases like this there’s a one-year statute of limitations and a three-year statute of repose,” Gottlieb said. 

11 crypto firms sued illegal ICOs
Tron Foundation CEO Justin Sun. (Photo: Tron)

That means there are two deadlines, he explained. The statute of limitations kicks in “a year from when you learn that it is an unregistered offering,” not from the date of the ICO.

However, the statute of repose adds another timeline, Gottlieb said. Regardless of whether buyers did or did not learn that an offering was an unregistered securities sale, they cannot sue more than three years after the ICO. That means “anything before April, 2017, will be off the table,” he added.

Take the example of the suit against the Tron Foundation, its CEO, Justin Sun, and former CTO Zhiqiang (Lucien) Chen. 

Noting that the Tron whitepaper, “expressly stated that ‘TRX is not a security,’” the suit claims that the $70 million ICO was actually a securities offering. 

However, that “was not clear to a reasonable investor at purchase,” it claimed.

Nor would it “have been reasonably apparent until, at the earliest, April 3, 2019, when the SEC released a detailed ‘Framework’ to analyze digital assets, indicating that TRX and other similar digital tokens are ‘investment contracts’ and therefore securities under Section 2 of the Securities Act of 1933,” the filing claimed.

The ICO took place between Aug. 31 and Sept. 2, 2017, so it falls within the three-year statute of repose.

What about The DAO Report?

That said, there is another potentially important date to consider: July 25, 2017. 

That is when the SEC issued its Report of Investigation on The DAO’s ICO, concluding that the DAO tokens sold in May 2016 were securities.

“I think that that settlement looms over all of these cases because people in the industry generally talk about the DAO settlement as the SEC statement that they were going to consider crypto offerings as unregistered securities offerings,” said Gottlieb. 

That ruling, he said “seems to be sort of a line in a sand, at least as far as SEC cases are concerned. If something happened before then they tend to go a little bit easier on it… but anything after that, they say, ‘you were on notice.’”

Gottlieb added, “I’ve actually filed a plaintiff’s case similar to this out in Los Angeles. Certainly, we make the same point, saying that after the DAO report, everyone in the industry knew or should have known that this was an unregistered securities offering.”

A long haul

Just because these lawsuits were filed with haste doesn’t mean they will see a courtroom anytime soon. Even after the courts reopen from the coronavirus break, it will be slow going, Gottlieb predicted. 

“They actually have to serve each of the defendants,” he said, noting that “service on a U.S. company tends to be very easy because it’ll be registered—if it’s registered—in Delaware. You can just mail something to the Delaware secretary of state.”

11 crypto firms sued illegal ICOs
Binance CEO Changpeng “CZ” Zhao (Photo: Binance)

Tracking down foreign companies can be much harder—particularly in an industry where it is not always clear where companies are actually headquartered. Binance, for example, is said to be headquartered in Malta, but on Feb. 21, the Malta Financial Services Authority issued a statement saying the company is not authorized to operate a cryptocurrency business there. It added, that the MFSA was “assessing if Binance has any activities in Malta which may not fall within the realm of regulatory oversight.”

A spokesperson for Binance said the firm did not have any comment about the class action lawsuit.

Then there’s serving the individuals, which is harder because they must be served in person, and there can be legal hoops to jump through when they live abroad—assuming they can be found. 

“It may be quite a while before service is fully executed in some of these cases,” Gottlieb noted.

That said, there is good reason to sue the executives personally, he added. For one thing, they may have the money. 

“If the company has been paying them personally handsomely, then the money from the company might be in their hands and not in the company’s hands,” said Gottlieb.

But largely, it is a strategic matter. Listing them as defendants forces them to sit and answer questions, he said, noting “it’s easier to get discovery from parties than from non-parties” to a lawsuit.

Beyond that, expect fights over whether U.S. courts have jurisdiction, which will depend on the specific facts of each case, he added. So, some of the cases may be thrown out altogether.

Just the facts

“Once you get past jurisdictional issues, there are factual issues,” cautioned Gottlieb. “It will be a significant endeavor to defend these suits on the facts.

Some more than others. Block.one recently paid $24 million to settle an SEC enforcement action calling its $4 billion ICO an illegal unregistered securities sale. 

11 crypto firms sued illegal ICOs
Block.one CEO Brendan Blumer (Photo: Wikipedia)

Asked about the current suit, a spokesperson told Modern Consensus that Block.one had not yet been served with the lawsuit. 

“We are aware of the opportunistic complaints filed against several blockchain and cryptocurrency companies… but are well prepared to address anything that may arise,” the emailed statement said.

In addition, Gottlieb said that the lawyers bringing these class action lawsuits were likely “emboldened” by a recent decision in the SEC’s enforcement action against messaging app turned blockchain developer Telegram.

In that case, Telegram held a SAFT in 2018, pre-selling 2.9 billion gram tokens usable on its forthcoming TON blockchain to 175 buyers for $1.7 billion. Because they were “accredited”—meaning rich—investors, the offering was exempt from normal SEC registration requirements under the much laxer Regulation D, Telegram argued. The plan was for those initial buyers to resell the tokens to the public when TON went live. That was originally scheduled for Oct. 31, 2019. 

Telegram argued that by the time the accredited buyer resold those grams to the public the active blockchain would have made them “utility” tokens, not securities. The SEC disagreed, and got an emergency order stopping the sale from Judge P. Kevin Castel of the Federal District Court for the Southern District of New York. On March 24, Judge Castel said both parts of the SAFT were actually a single securities offering.

Gottlieb added that Judge Castel “took pains to explain in that case, his decision was as a matter of fact. He’s saying that there is a substantial likelihood of success on the merits that the SEC could show that there was a violation of securities laws. He’s not saying it’s 100% there was a violation, but his opinion would certainly lead you to that conclusion.”

From the frying pan into the fire

These class action lawsuits are not necessarily the end of the 11 firms’ problems. While Block.one has already been through the wringer with the SEC, most of the defendants have not faced enforcement actions. 

“Anytime there’s a private suit in this area, obviously it may attract the attention of the SEC, and that’s something folks want to avoid,” Gottlieb said. “The plaintiffs can collect a whole pile of documents that the SEC can then easily obtain. Sometimes the SEC will just sit back and see what happens, rather than having to do the work itself.”

What does this mean to the plaintiffs in these 11 cases? 

“Let’s just say that anyone who’s defending these companies should be particularly sensitive, not just to what’s going on in this case, but what’s going on in the larger regulatory climate to ensure that their defense is not jumping from frying pan to fire,” said Gottlieb. 

He added: “You don’t know which of these companies was already on the SEC radar.”

Who’s under fire

The cases are against the following cryptocurrency issuers and exchanges, and their executives:

Bancor (BNT-USD): Bprotocol Foundation, Eyal Hertzog, Yehuda Levi, Guy Benartzi, and Galia Benartzi (Docket: 1:20-cv-02810)

Block.one (EOS): Block.one, Brendan Blumer, and Dan Larimer (Docket: 1:20-cv-02809)

Civic (CVC): Civic Technologies, Inc., Vinny Lingham, and Jonathan Smith (Docket: 1:20-cv-02811)

Kyber Network (KNC): KayDex Pte. Ltd., Loi Luu, Victor Tran, and Yaron Velner (Docket: 1:20-cv-02812)

Quantstamp (QSP): Quantstamp, Inc., Richard Ma, and Steven Stewart (Docket: 1:20-cv-02813)

Status (SNT): Status Research & Development GmbH, Jarrad Hope, and Carl Bennetts (Docket: 1:20-cv-02815)

Tron (TRX): The Tron Foundation, Justin Sun,  and Zhiqiang (Lucien) Chen (Docket: 1:20-cv-02804)

BiBox exchange: Bibox Group Holdings Limited, Bibox Technology Ltd., Bibox Technology Oü, Wanlin “Aries” Wang, Ji “Kevin” Ma, and Jeffrey Lei (Docket: 1:20-cv-02807)

Binance exchange: Binance, Changpeng “CZ” Zhao, Yi He, and Roger Wang (Docket: 1:20-cv-02803)

BitMex exchange: HDR Global Trading Limited, ABS Global Trading Limited; Arthur Hayes; Ben Delo, and Samuel Reed (Docket: 1:20-cv-02805)

KuCoin exchange: Kucoin, Michael Gan, Johnny Lyu, and Status Research & Development Eric Don  (Docket: 1:20-cv-02806)

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Leo Jakobson, Modern Consensus editor-in-chief, is a New York-based journalist who has traveled the world writing about incentive travel. He has also covered consumer and employee engagement, small business, the East Coast side of the Internet boom and bust, and New York City crime, nightlife, and politics. Disclosure: Jakobson has put some 401k money into Grayscale Bitcoin Trust.