In the U.S. there has been an notable uptick in class action lawsuits launched against companies in the cryptocurrency market in late 2017. As public attention turned to the roller-coaster ride of cryptocurrency markets over the past year, it is not surprising that ambitious class counsel have jumped on the ride by issuing their first putative class actions against companies funded through initial coin/token offerings (ICO) and companies that are otherwise active in the cryptocurrency space. With over $3 billion dollars raised through ICOs in 2017, and few signs of the market dynamics changing any time soon, we expect that this trend will continue in 2018.
The Emergence of a Trend in the U.S.
The trend began in October of 2017 in the fallout of Tezos’s $232 million ICO when the company was named as a defendant to a putative class action lawsuit after the company faced issues getting off the ground with the release of its digital coins, called “Tezzies”. In November and December three more putative class actions were filed naming the company, along with its founders and certain other related entities, as defendants. In each case, the claims center around allegations that Tezos sold unregistered securities and deceptively marketed the sale of the company’s Tezzies.
On December 13, 2017, the same day that a fourth class action lawsuit was issued against Tezos, Centra was hit with a putative class action alleging that its investors were victims of deceptive statements and sold an unregistered security. The company had offered investors an opportunity to trade their various cryptocurrencies for Centra’s own cryptocurrency which it publicly stated could be traded through existing credit card networks. The company raised $30 million in its ICO, but faced delays developing and launching its digital currency.
A third company, Monkey Capital, was hit with a putative class action in late December after it had launched a pre-sale of cryptocurrency options that were to be later used to purchase “Monkey Coins” which never became available. Once again, the claim alleges that investors were victims of deceptive statements and that the pre-sale amounted to an unregistered securities offering.
Finally, The Crypto Company, which advertises itself as a cryptocurrency consultant and technology developer, had trading in its shares suspended by the U.S. Securities and Exchange Commission (SEC) on December 19, 2017 due to “concerns regarding the accuracy and adequacy of information in the marketplace” about promotion, compensation and share sells planned by the company as well as potentially manipulative trading. On January 5, 2018, a putative class action was filed against the company and certain of its officers and directors alleging that investors were victims of deceptive statements, and that the company engaged in a scheme to promote and manipulate the company’s stock.
Potential Applicability in Canada
Canadian companies have not escaped the trend as class counsel based in the U.S. have announced that they are investigating the possibility of a class action against Vancouver-based First Bitcoin Capital Corp. First Bitcoin Capital is a public company with its securities trading over the counter on OTC markets. While not required to file information with the SEC as an over the counter security, OTC Markets’ quotation system “OTC Link” is registered with U.S. regulators as a broker-dealer and is a member of the U.S. Financial Industry Regulatory Authority. On August 24, 2017, trading in First Bitcoin Capital’s securities was suspended by the SEC after major volatility in the value of the company’s securities through August, including a 7000% increase. Shortly after the suspension, three different class action law firms made public statements that they were investigating potential class actions against the company for possible allegations of misleading or deceptive statements.
As we have previously commented, the regulatory reach over of ICOs is complex and largely untested waters in Canada. It remains unclear whether, and in what circumstances, coins or tokens offered in ICOs qualify as securities. If they do, that opens the floodgates for regulatory proceedings and civil securities class actions.
i) the approach of the regulators
In a Staff Notice published in August 2017, the Canadian Securities Administrators (CSA) took the position that “in many cases, when the totality of the offering or arrangement is considered, the coins/tokens should properly be considered securities”. The CSA has stated that if an individual purchases coins/tokens whose value is tied to the future profits or success of a business, these will likely be considered securities. The definition of a “security” under Canadian securities laws is broad and, in Ontario, includes “any investment contract”. According to the CSA, an investment contract may exist if an ICO includes: (a) an investment of money; (b) in a common enterprise; (c) with the expectation of profit; and, (d) to come significantly from the efforts of others. A test similar to this was applied by the SEC when it determined in one case this past July that a cryptocurrency was a security.
If a company’s coin/token is found to be a security, we can expect Canadian securities regulators to take the position that an ICO must be accompanied by a prospectus or otherwise qualify for one of the prospectus exemptions, such as the accredited investor or offering memorandum exemptions. While ICOs are often accompanied by a white paper, the existence of a white paper likely will not excuse a company from complying with any applicable obligation to file a prospectus or offering memorandum. We are not aware of any business that has used a prospectus to conduct an ICO in Canada, but we are aware of at least two companies, Impak Finance Inc. and Token Funder Inc., that were approved for ICOs under the offering memorandum exemption.
ii) potential for civil actions
There is also a serious question about whether Canadian companies issuing coins/tokens may find themselves exposed to civil liability for potential misrepresentations in their public statements, whether in a prospectus, offering memorandum, white paper or other publicly available document. As we have seen in the U.S. cases above, class counsel are not shy from alleging civil liability for false or deceptive statements made before or during an ICO. Such civil claims could include allegations of:
- primary market liability under s. 130 or s. 130.1 of the Ontario Securities Act, and its equivalents, by purchasers in an ICO qualified by a prospectus or offering memorandum for alleged misrepresentations in those documents that would reasonably be expected to have a significant effect on the market price or value of the coin/token;
- secondary market liability under Part XXIII.1 of the Ontario Securities Act, and its equivalents, by peer-to-peer purchasers of a company’s coins/tokens in the market after an ICO, where such purchasers allege that public statements made by the “issuer” of the coin/token contained misrepresentations that would reasonably be expected to have a significant effect on the market price or value of the coin/token; and
- negligent misrepresentation under the common law where statements made by the company issuing the coin/token are: untrue or misleading, made in a circumstance where the company owed a duty of care to purchasers, negligently made, and detrimentally relied on by the purchasers.
Lastly, Canadian companies should be wary of the “long-arm” jurisdiction provided by Canadian securities laws extending secondary market liability to “responsible issuers” which have “a real and substantial connection” to a province, the securities of which are publicly traded outside the province (see our commentary on this issue here). In other words, cryptocurrency companies may find themselves vulnerable to secondary market liability even where their securities do not trade over the facilities of any Canadian exchange. The fact that a coin/token trades on a cryptocurrency exchange or even over the counter may not mean that it is immune from being found to be “publicly traded” under Canadian securities laws.