On April 3, 11 class action lawsuits were filed in the Southern District of New York against four crypto-asset exchanges and seven digital token issuers. The plaintiffs allege that the defendants offered and sold billions of dollars of unregistered tokens and other financial instruments to investors in violation of federal and state securities laws.
According to a press release by a lead partner on the cases, “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.”
He adds that, in addition to receiving fees for each transaction performed on its exchange, a given defendant allegedly received large cash payments from issuers seeking to list tokens, with these fees often exceeding $1 million per listing. The exchanges, Roche says, “profited handsomely.”
The core allegations in the lawsuit stem from the plaintiff’s claims that the digital tokens that the defendants issued and sold are unregistered securities. According to the allegations, the investors purchased these tokens between 2017 and the present. Note, however, that the Securities Act of 1933 allows investors to bring a private cause of action for offering or selling securities in violation of Section 5 of the Securities Act, so long as the claim is brought within one year after the violation upon which it is based and certain other criteria are met.
To overcome this statute of limitations, it’s expected that the plaintiffs will take the position that the statute of limitations did not start its clock until April 3, 2019, the date in which the Framework for “Investment Contract” Analysis was issued. According to the plaintiffs, “prior to that time, a reasonable investor would not have believed that these Tokens were securities that should have been registered with the [Securities and Exchange Commission (SEC)].” They also allege that “before the SEC issued its Framework in April 2019, a reasonable investor would not have concluded that ERC-20 tokens were generally securities subject to the securities laws.”
A potential issue for the plaintiff’s is the aforementioned Framework was not issued by the SEC, as they asserted; rather, by the Strategic Hub for Innovation and Financial Technology of the Securities and Exchange Commission. In a 2018 statement by the SEC’s chairman Jay Clayton, “all staff statements are nonbinding and create no enforceable legal rights or obligations of the Commission or other parties.” And, as per the first footnote of the Framework, it “represents the views of the Strategic Hub for Innovation and Financial Technology” and it does “not replace or supersede existing case law, legal requirements, or statements or guidance from the Commission or Staff.”
Defendants, however, will likely point to the SEC’s guidance, speeches and enforcement actions, including a July 2017 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO. The DAO report, as it’s commonly referred to, applied the Howey analysis (which provides criteria used to analyze what constitutes an investment contract) to a digital asset called the DAO token and found that it was a security under the Securities Act of 1933 and the Securities Exchange Act of 1934.
The report said, “all securities offered and sold in the United States must be registered with the Commission or must qualify for an exemption from the registration requirements” and that “any entity or person engaging in the activities of an exchange must register as a national securities exchange or operate pursuant to an exemption from such registration.”
One former SEC regulator with experience in regard to the Securities Act says the plaintiff’s position is “creative” but will probably not be successful.