A federal judge’s recent refusal to approve Block.one’s $27.5 million settlement with investors highlights the challenges facing cryptocurrency investors trying to get their money back in the framework. class action lawsuits against companies based outside the United States.
Block.one, a Cayman Islands-based blockchain technology developer, has agreed to the settlement to end a lawsuit brought by Crypto Assets Opportunity Fund over a token sale by the company several years ago.
U.S. District Judge Lewis Kaplan for the Southern District of New York declined to give final approval to the proposed settlement on August 15. – and when it takes place abroad.
The case illustrates “the difficulty of trying to determine whether you have a transaction in the United States,” said Proskauer Rose LLP attorney Jonathan Richman. The decision also underscores the challenges of dealing with these issues class-wide.
Kaplan said he was not convinced that Crypto Assets, which bought tokens in foreign and US transactions, could adequately represent the interests of investors whose transactions took place primarily in the United States.
“You’re going to have to deal with differences between class members as to whether or not they have transactions that fall under US securities laws,” Richman said.
Cryptocurrency-related collective investor actions are poised to hit an all-time high in 2022, according to a recent report from Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse. Ten class actions were filed in the first half of 2022, compared to 11 throughout last year.
A 2010 Supreme Court decision, Morrison v. National Australia Bank, limited the scope of US securities law to securities listed on national stock exchanges and “domestic transactions” in other securities.
Various circuit courts, including the United States Court of Appeals for the Second Circuit, agree that a transaction is domestic if “irrevocable liability” passes from the seller to the investor in the United States. Courts, however, are grappling with what “irrevocable liability” means in the context of a blockchain transaction.
“The more complex an international transaction, the more difficult it is often to tell where it belongs,” said Robert Schwinger, attorney for Norton Rose Fulbright US LLP.
With blockchain, “when the thing goes through many, many computer nodes around the world, it’s a lot more complicated than your traditional securities scenario,” Schwinger said. A node refers to a computer linked to the cryptocurrency network.
In a case involving the Tezos blockchain project, a California district court judge said a transaction became irrevocable “after being validated by a network of global ‘nodes’ clustered more densely in the United States than in any other country”.
A New York judge, in a case brought by investors who bought the HelbizCoin cryptocurrency, focused on the buyer’s location at the time of the transaction. In Utah, a district court found that transactions in securities sold over the Internet occur at both the seller’s and the buyer’s.
“There are at least nuanced differences in the existing case law regarding the attempt to determine where irrevocable liability arises between buyer and seller in a blockchain transaction,” Richman said. “It’s certainly evolving.”
Kaplan appeared to question some of the existing approaches in the case against Block.one.
Without deciding which test is correct, Kaplan suggested that what matters may be the location of the first node that verified the transaction, since that is what makes the transaction binding. Such a test “appears to be manageable” and follows precedent, he said.
Questions about the right approach are something that should continue to be litigated.
“I see this happening more often as we have an increasing number of private claims,” said Carol Rose Goforth, a law professor at the University of Arkansas.
One advantage of a first node test is that it’s simple, said Samuel Dibble, an attorney at Baker Botts LLP, although it’s unclear if it can scale to all blockchain transactions. The simplicity of the test has the potential to create problems.
“People will try to evade US jurisdiction by directing traffic out for first node verification,” said Indiana University law professor Sarah Hughes.
Investors sued Block.one in 2020, alleging the company defrauded them “through an illegal one-year Initial Coin Offering”. Block.one agreed the previous year to pay $24 million to settle Securities and Exchange Commission allegations that it sold unregistered securities.
Block.one has maintained the investors’ lawsuit is “baseless” and “filled with numerous inaccuracies”.
The inability of crypto investors to link transactions in the United States may be a reason for courts to dismiss a lawsuit. The Block.one case shows how the issue can raise issues at other stages of litigation and stand in the way of a settlement.
Kaplan feared that Crypto Assets would be incentivized to accept a lower settlement offer than would have been demanded by investors who primarily engaged in transactions in the United States. He noted that the deal was 75% below the alleged total loss “largely due to the presence of foreign purchases”.
The judge said it ‘involves no fault or criticism of the principal plaintiff or his experienced and well-regarded lead counsel’. Rather, it was “a structural problem with its roots in the unusual market involved in the case”.
There could be solutions to this type of problem, say the lawyers. On Monday, an individual who said almost all of his token purchases were domestic asked be substituted as lead plaintiff in the litigation.
Still, Kaplan’s decision is “definitely a warning that [these cases] are complicated,” Richman said.