Front view of Eos cryptocurrency over computer video card.Bitcoin mining farm concept.
getty
A United States district court shot down a proposed $27.5 million settlement in a class-action lawsuit against Cayman Islands-based Block.one, that alleged a 2017 initial coin offering by the developer behind EOS
EOS
.IO blockchain, was an unregistered securities sale. The court’s decision raised questions about how to determine which blockchain transactions are considered domestic and subject to U.S. securities law.
In 2019, the SEC fined Block.one $24 million for conducting an unregistered securities offering. The company paid the penalty without admitting to the regulator’s findings. In the class-action case, the court rejected the settlement on the grounds that the lead plaintiff in the case, Crypto Assets Opportunity Fund, is not an adequate class representative. The class represented by Crypto Assets Opportunity Fund includes individuals in and outside of the United States. The court ruled the U.S.-based fund’s foreign versus domestic token purchases do not proportionally align with the breakdown of the entire class, an issue because of different treatment for potential damages.
Over the course of a year, Block.One sold ERC-20 tokens with the expectation they could later be exchanged for EOS tokens. Block.One raised 7.12 million ether worth $4.1 billion in exchange for 900 million ERC-20 tokens. The suit alleges that Block.One attempted to keep the ICO outside of federal securities law by stating that the tokens did not constitute an investment contract and preventing direct sales to U.S. persons. But Block.One ERC-20 tokens were available for resale domestically immediately after the ICO. The company also advertised to U.S. residents through social media campaigns, public appearances and a Times Square billboard, the suit alleges.
The court’s decision included a discussion of how to determine whether a blockchain transaction is domestic and subject to U.S. securities law. The first consideration was whether the purchase had been made through a U.S.-based exchange. In the case of Block.One, cryptocurrency exchange Poloniex is considered by the SEC a national exchange, so tokens purchased through the platform would be considered domestic.
U.S. securities law also applies to domestic transactions in securities not listed on American exchanges. It is more difficult to determine if a transaction is domestic when it was carried out on a distributed ledger like blockchain. The court stated that an individual being in the United States at the time of a transaction does not necessarily make it a domestic transaction. Additionally, the location of network nodes is not enough to make a determination. The court decided that determining whether foreign exchange transactions are subject to securities law should be considered on a case-by-case basis.
There is debate over which digital assets may qualify as securities in the United States. Last month, The U.S. Securities and Exchange Commission alleged that nine crypto assets involved in an insider trading lawsuit are securities. At the same time, the regulator reportedly opened a probe into leading crypto exchange Coinbase over whether some of the assets it lists are unregistered securities. The discussion about which blockchain transactions qualify as domestic or foreign illustrates that establishing securities criteria for digital assets is only one of the regulatory hurdles for the industry.
“There are a lot more profound questions out there that I think will have, in addition to this case, wide ramifications as to how we understand financial transactions in the future,” Timothy Spangler, a partner specializing in financial technology at Dechert law firm, said. “As more and more assets go onto blockchain, these questions are only going to occur more and more.”
Ultimately, the court did not make a decision on the geographic reach of U.S. securities law when it comes to blockchain transactions. However, it did rule that the class represented by the Crypto Assets Opportunity Fund may have conflicting interests because domestic ERC-20 and EOS transactions are eligible for damages, but foreign transactions are not. The court expressed concern that if Crypto Assets Opportunity Fund had a higher percentage of foreign transactions than the entire class, the company would have reason to accept a lower settlement than those who had made more domestic transactions.
“Lead plaintiff, in view of the proportion of its investments made in domestic versus foreign transactions, may have had an incentive to accept a lower settlement offer than would have been insisted upon by absent class members who purchased only or more predominantly in domestic transactions,” the opinion signed by Judge Lewis A. Kaplan reads.
The lawsuit alleges that the ERC-20 tokens sold by Block.One and its founders — Brock Pierce, Brenden Blumer and Daniel Larimer — to fund the development of the EOS blockchain constituted an unregistered securities offering. The suit adds that promises made that the EOS blockchain would be decentralized were misleading and that the individual defendants improperly pocketed ICO proceeds.
