CRYPTOCURRENCY SECURITIES AND FINANCIAL FRAUD

Since the middle of 2018, cryptocurrency lawsuits alleging various forms of financial fraud have become increasingly common. In some ways, the story is familiar -- the price went up suddenly at the beginning of 2018, and then it crashed through the proverbial floor. The lawsuits followed.

In other ways, the story is new and confusing. What are Bitcoin, Ethereum, ZCash, Ripple and other forms of cryptocurrency? Are they money? Are they like securities, debt instruments, game tokens or memberships? What law governs them? The courts are still sorting through these important questions. One thing is clear. There will be more lawsuits.

In its Securities Litigation Report of 2018 , the legal analytics firm Lex Machina found 45 cryptocurrency lawsuits filed during the first half of 2018, up from 15 in 2017. It’s still not a flood of lawsuits, but it’s a huge increase.

In U.S. v. Zaslavskiy , defendant Maksim Zaslavskiy founded two companies called REcoin Group Foundation, LLC (REcoin) and DRC World, Inc. (Diamond). From January 2017 to October 2017, REcoin and Diamond engaged in initial coin offerings (ICOs) through which investors purchased cryptocurrency tokens issued by the companies. In its criminal indictment, the government alleged that, contrary to Zaslavskiy’s representations, the ICOs were not backed by real estate investments and diamonds. As a result, the U.S. Attorney’s Office for the Eastern District of New York brought criminal charges against Zaslavskiy for securities fraud in connection with the ICOs.

As of this writing, the lawsuit has survived a motion to dismiss. The court has refused to rule, except perhaps by implication, that the tokens at issue qualify as securities, rather than, as claimed by the defendant, mere evidence of “membership” in an investment scheme. A definitive ruling on the all-important securities law question will happen at a later date.

In Miller v. Longfin and Wei v. Longfin , two sets of investors sued Longfin Corp., a global cryptocurrency company, alleging violations of Sections 10(b) and 20(a) of the federal Securities Exchange Act.

The investors allege that Longfin misrepresented the location of its primary offices and the identity of key employees in its public statements; had numerous material weaknesses in its operations and internal financial reporting controls; and was ineligible for inclusion in certain stock indices. The investors claim that when this information was made public, Longfin’s stock value declined more than 86 percent in two weeks. The investors are attempting to recover damages associated with the decline in stock value.

In Brola v. Nano , investors filed a class action lawsuit against a block chain developer and cryptocurrency issuer, alleging that it engaged in an unregistered offering and sale of securities by issuing cryptocurrencies on BitGrail, an Italian cryptocurrency exchange, in violation of Sections 12(a) and 15(a) of the Securities Act. The complaint also alleges that Nano wrongly encouraged investors to invest assets with BitGrail, which lost $170 million worth of the cryptocurrency “XRB” due to a hack on the exchange platform. The investors ask for, among other things, rescission of their investments.

In Paige v. Bitconnect , the plaintiff, Brian Paige, alleges that the UK-based company performed no real business activity, but merely “relied on new money from new users, who were in turn expected to get more new users to produce more new money.” It was a Ponzi scheme in violation of Kentucky and federal securities laws, as well as state consumer protection laws.

More securities and financial fraud lawsuits are certainly in the works.

That is the big question. The law usually plays catch-up to new technologies and the Bitconnect lawsuit is a good example. None of the existing laws quite fit the newest forms of cryptocurrency financial fraud. Until legislatures enact laws specific to cryptocurrencies, savvy lawyers will look for every option under common law, as well as existing state and federal consumer and securities statutes.

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Published on Nov-1-18