Litigation tarnishes ICOs
A recent spike in initial coin offerings (ICOs) has been met with an equally fierce wave of lawsuits, with complaints ranging from unfair competition to false advertising, legal analysts have noted. As regulators struggle to find a place for cryptocurrencies in the financial ecosystem, complainants have filed 13 actions against ICOs in federal and state courts. While two of the cases were summarily dismissed, the remainder have pending statuses in the following districts: five in Northern California, three in Southern Florida, one in Southern New York, one in Western Kentucky, and one in Minnesota.
Legal analysts are watching the high-profile case against Centra in New York federal court. The Security and Exchange Commission is investigating possible fraudulent activities in the company's 2017 ICO. Centra, previously endorsed by former boxer Floyd Mayweather, faces fines and up to $32 million in repayment if convicted, analysts noted.
Five litigious cryptocurrency trends
Financial services litigator William Pao, attorney at O'Melveny & Meyers LLP, expects to see more legal actions against cryptocurrencies in 2018. For example, on Jan. 5, 2018, the SEC temporarily suspended trading in shares of UBI Blockchain Internet Ltd. over questionable business operations related to the company's common stock, Pao noted. The SEC took similar actions against First Bitcoin Capital Corp., CIAO Group, Strategic Global and Sunshine Capital.
In an O'Melveny blog post published Feb. 8, 2018, titled "Five Crypto-Securities Trends That Spell More Lawsuits in 2018," Pao and several O'Melveny colleagues cited the following five factors that make cryptocurrencies prone to legal actions:
- Cryptocurrencies as securities: SEC Chairman Jay Clayton stated in November 2017 that ICOs have a sufficient number of hallmarks to be considered securities. Their quasi-security status puts cryptocurrencies at risk of being tried as securities in state and federal courts of law, the authors stated.
- Extreme pricing volatility: ICO participants who pay for tokens with Bitcoin or Ether tend to react strongly when those tokens appreciate, the authors noted. In fact, many buyers try to rescind ICO token purchases after seeing their Bitcoin and Ether appreciate while the newly acquired tokens decline in value, the authors noted. As token buyers look for ways to mitigate losses, the authors expect more crypto-securities lawsuits to ensue.
- Successful ICO controversies: The authors predict ICO activities will escalate, inevitably attracting more lawsuits. "Unfortunately, the more successful an ICO, the more attractive the amount in controversy is to plaintiffs' lawyers," the attorneys wrote. "It comes as no surprise, therefore, that the Tezos Foundation—whose $232 million sale for its "Tezzies" tokens broke records at the time—is named in five private crypto-securities suits." The authors additionally noted the cryptocurrency investment platform Bitconnect is facing three lawsuits. The Bitconnect proprietary token had a market cap of over $2.5 billion in January 2018, they stated.
- Opportunistic attorneys: ICOs are drawing interest from numerous plaintiffs, who are drawn to the payday potential of crypto-securities lawsuits. The authors noted eight law firms, including some that specialize in securities law, were vying for positions as lead plaintiffs' counsel in the Tezos case.
- Jurisdictional tactics: The borderless aspects of ICOs attract remote token buyers from around the world, the authors noted, adding that this makes it critical for plaintiffs to assert their jurisdiction in U.S. courts. "So far, plaintiffs have generally succeeded in establishing U.S. jurisdiction over crypto-companies," they wrote. "If plaintiffs are able to successfully establish jurisdiction based on wherever they bought a token, many crypto-companies—even those with minimal U.S. contacts—may find themselves hauled into American courts."
The authors expect lawsuits will continue to proliferate in direct proportion to escalating ICO activities. As legislators and regulators debate the merits and legitimacy of cryptocurrencies, market participants will need to consider and evaluate these trends, they noted.
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