Crypto Mewn Argyfwng? Mae Lewis Cohen a Greg Strong yn Rhannu Eu Barn ar Gyfreithiau Cyfreithiol Diweddar

The tide has turned in the crypto industry. The stories in the press concerning announcements of new protocols have increasingly been replaced with announcements around enforcement actions by the Securities and Exchange Commission as they have clamped down on historical Initial Coin Offerings which have now mostly been deemed to have been illegal securities offerings.

The success of these actions by the regulators has started to embolden private sector parties in going after both issuers of new crypto assets as well as crypto-exchanges. In April alone, there were 11 class action suits filed in the Southern District of New York against four crypto-asset exchanges and seven digital token issuers. At the core of these proceedings is the complaint that exchanges including Binance, Bibox, BitMEX and KuCoin, as well as seven issuers of digital tokens: Block.one, Tron, Bancor, Civic, Kybercoin, Quantstamp, and Status failed to comply with federal and state securities laws intended to protect investors from unscrupulous behavior.

While these complaints are varied in nature, they center around the notion that issuers were responsible for illegally offering unregistered securities to U.S. investors, and that crypto-exchanges are guilty of facilitating the trade of securities without the requisite licenses. Moreover, some of the allegations suggest that these exchanges have been involved in elaborate schemes of fraud, manipulation and insider trading.

Earlier in the month, I interviewed Lewis Cohen and Greg Strong from crypto law experts DLx Law to understand more about the arguments that the complainants in these cases are making in their civil lawsuits, their validity and the potential implications of these suits for the blockchain and cryptocurrency sector as a whole.

The Statute Of Liabilities May Not Have Run Out As Originally Suggested

One key challenge that many of the recent civil class action lawsuits will face is that the strict one-year statute of limitations for bringing these cases may have expired. In other words, the plaintiff filed too late according to the statute of limitation provisions in U.S. securities law for the violation of selling an unregistered security, since the sales in question took place more than one year ago. Andrea Tinianow, contributor to Forbes pointed this allan earlier in April this year.

Lewis and Greg agree that that this may be a challenge but suggest that the plaintiffs could argue that the law regarding the classification of the various digital tokens as securities has been ambiguous and that it wasn’t until the Securities and Exchange Commission published their framework guidance in April 2019 that a reasonable purchaser had clarity with respect to determining whether the SEC would consider a particular digital asset as a security.

The plaintiffs in the class action suits may argue that the statute of limitations on their claims can only start when someone conducting reasonable due diligence would have been made aware of the violation. Thus, they may argue, the one-year statute of limitation clock should only start running from the time the SEC clarified its position in its April 2019 guidance. If this position is accepted by the court, the class actions would be allowed to proceed as long as they were brought within the applicable statute of repose timeframe, if any.

Many Of The Defendants Are Not Based In The U.S.

Another challenge relates to defendants in the cases that are not based in the U.S., and instead operate from offshore locations where local regulations are more permissive of their activities. These defendants may argue that they do not make their services available to U.S. customers and take reasonable measures to exclude them.

To succeed, the plaintiffs will need to be able to argue that, although these defendants are based outside of the U.S., they are still doing business here. This may be evidenced by U.S. citizens having accounts on their platforms, by job postings for roles in the U.S., through these entities actively participating in conferences in the U.S. and thereby soliciting U.S. users, or by other means – it will be up to the plaintiffs to make this case.

In the case of Bitmex, while it claims to have no operations in the U.S. and has taken steps block users in the country, the suit against them claims that according to “sources close to the company,” nearly 15%, or $138 billion, of the trading volume on the exchange is attributable to U.S. traders. According to Strong, the question therefore becomes the extent to which the exchange has taken measures to exclude U.S. citizens, whether through strong KYC checks or by banning U.S.-based I.P. addresses as well as those accounts using VPNs that could indicate U.S. users seeing to mask their identity.

According to both lawyers, the plaintiffs may have some success in being able to argue the point that the defendants in these cases are subject to U.S. jurisdiction. Historically, courts have had a reasonably low bar for proof of operating in the U.S. and, in a recent separate suit against offshore crypto exchange Bitfinex, the New York Attorney General pointed to the myriad ways that Bitfinex engaged in business in New York to support their argument for New York jurisdiction.

However, for Cohen, even if U.S. jurisdiction is established and the courts ultimately rule in the plaintiffs’ favor, a bigger hurdle will be whether the plaintiffs will be able to collect any damages from the various offshore defendants, given that these defendants are unlikely to have any significant assets in the U.S. Regarding assets of the defendants located outside of the U.S., the plaintiffs will likely have significant difficulty collecting on any judgments obtained, absent commencing a new judicial proceeding in the jurisdictions in which the assets are located. An additional issue is that, where most of the defendants’ assets are in the form of Bitcoin, Ether or other cryptocurrencies, the law in most jurisdictions is not developed on how to enforce a claim against assets of this type.

Taken together, these issues will likely be a significant hurdle for the class action suits – is it really going to be worth the expense of pursuing these cases in the U.S. if the plaintiffs ultimately can’t collect on their judgments?

The Legal Status Of Digital Tokens And Cryptocurrencies Remains Open

A key issue concerning the exchange defendants in particular concerns the determination of whether the digital tokens that are listed on the various exchange defendants are properly classified “securities”. If they are, and assuming there is jurisdiction in the United States, then crypto-exchanges like Bitmex would have needed to register for broker dealer licenses in the U.S. and become an Alternative Trading System (or, alternatively, register as a national exchange, although this is highly impractical).

In the case of Bitcoin and Ether, the SEC has been fairly clear that these cryptocurrencies are not “securities”. The Commodities Futures Trading Commission on the other hand has been more definite that, in their view, these digital assets constitute “commodities”. However, the crypto-exchanges named as defendants in the class action lawsuits, despite facilitating the spot trading of Bitcoin and Ether, haven’t been subject to a publicly announced investigation by the CFTC or been subject to publicly reported enforcement actions by the agency.

Cohen and Strong explain that this may be because of the scope of the CFTC’s regulatory remit. Although markets that facilitate spot exchanges of commodities for U.S. persons are subject to anti-fraud oversight by the CTFC, the Agency’s efforts are primarily focused on the regulation of futures and derivatives markets for commodities.

That, explains Cohen, is because the spot trading of commodities like cotton, orange juice and crude oil has traditionally been a commercial activity, involving physical delivery of bulk quantities of the relevant item – something that is only practical for larger businesses.

Retail traders, on the other hand, prefer to trade commodities in the form of options, swaps and contracts for future delivery that can be settled by offset without a requirement of arranging for a costly physical delivery. By and large, commercial entities trading in spot markets for physical commodities are better able to defend their interests and do not require the level of regulatory protections generally accorded retail traders in futures and derivatives markets.

The trading of Bitcoin and Ether is a fundamentally different construct – these commodities can be bought, sold and delivered immediately in vast quantities using just a desktop computer or mobile device. As a result, a significant number of retail users have been accessing these spot markets – an area that to date has not seen much CFTC enforcement activity (with the notable exception of enforcement activity in the area of binary options in traditional foreign exchange markets).

However, where the CTFC has greater enforcement abilities is around aspects of margin and leverage trading offered to retail customers, products that cryptocurrency exchange Bitmex is particularly well known for. These activities sit firmly within the Agency’s remit, and so the CFTC is on much firmer ground for pursuing non-compliance by crypto-exchanges engaging in this activity.

Leaving Bitcoin and Ether aside, the classification of other digital tokens is less clear. Cohen and Strong point to the recent Telegram case, where the CFTC submitted a letter to the Southern District Court judge asserting that virtual currencies are commodities, but also noting that a commodity can also be classified as a “security” by the SEC. That brings some clarity, but there’s still the aspect of how the digital token was first sold that also impacts the analysis.

According to Cohen, it is well settled that when any asset, including a digital token, is sold under circumstances that meet the Howey test, that those transactions will be considered “investment contracts” and will be subject to U.S. securities laws. What is less certain is whether these tokens themselves actually are or represent a “security”.

That’s an important nuance – an issuer may have violated securities law by offering or selling digital tokens to U.S. individuals in an Initial Coin Offering without registering these transactions. But it is also possible that the digital tokens themselves represent nothing more than computer code that allows the “owner” to give a valid instruction to a blockchain-based network – most digital tokens do not represent or convey any ownership rights in a business (the key characteristic of equity) nor do they entitle the “owner” to a right to repayment that is the hallmark of a debt instrument. As a result, these digital tokens may actually not be securities themselves.

According to Cohen, that position is supported by Judge Castel of the U.S. District Court in the Southern District of New York, who issued the order in the Telegram case. Judge Castel stated in his second order in the case that the “security” offered and sold by Telegram without appropriate registration was not the TON token nor relevant purchase agreement for the TON tokens. Rather, Judge Castel noted, the “security” was the entirety of the Telegram’s fundraising scheme .

And this could turn out to be the crux of the matter in the civil cases involving the exchanges – were the exchanges facilitating the trading of tokens that should properly be considered “securities” and as such violating the law by not having the requisite licenses to facilitate these exchanges? Alternatively, although the fundraising through the unregistered issuance of tokens may have violated U.S. securities law , but as the relevant tokens are nothing more than computer code without ownership or indebtedness rights attached, are crypto-exchanges free to facilitate trading of these digital tokens without themselves violating U.S. securities law?

That may turn out to be the most interesting of the multi-million-dollar questions to come out of these cases.

Source: https://www.forbes.com/sites/benjessel/2020/06/30/an-interview-with-lewis-cohen-and-greg-strong-from-blockchain-and-tech-law-firm-dlx-law/