A federal judge’s recent refusal to approve Block.one’s $27.5 million settlement with investors highlights challenges facing cryptocurrency investors trying to recoup their money in class action lawsuits against companies based outside the US.
Block.one, a blockchain-technology developer based in the Cayman Islands, agreed to the settlement to end a suit brought by Crypto Assets Opportunity Fund related to a token sale by the firm several years ago.
U.S. District Judge Lewis Kaplan of the Southern District of New York declined to give final approval to the proposed settlement on Aug. 15. The ruling wrestled with how to decide when a blockchain transaction takes place in the US—and is covered by US securities laws—and when it takes place abroad.
The case illustrates “the difficulty of trying to determine whether you have a US transaction,” Proskauer Rose LLP attorney Jonathan Richman said. The ruling also underscores the challenges of dealing with those questions on a classwide basis.
Kaplan said he wasn’t convinced that Crypto Assets, which purchased tokens in both foreign and US transactions, could adequately represent the interests of investors whose transactions predominately took place in the US.
“You’re going to have to deal with the differences among the class members in terms of whether they do or don’t have transactions that are subject to the US securities laws,” Richman said.
Investor class actions related to cryptocurrency are on track to hit a record high in 2022, a recent report from Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse shows. Ten class actions were filed in the first half of 2022, compared to 11 during all of last year.
A 2010 Supreme Court ruling, Morrison v. National Australia Bank, limited the reach of US securities law to securities listed on domestic exchanges and to “domestic transactions” in other securities.
Various circuit courts, including the U.S. Court of Appeals for the Second Circuit, agree a transaction is domestic if “irrevocable liability” shifted from the seller to the investor in the US. Courts are grappling, however, with what “irrevocable liability” means in the context of a blockchain transaction.
“The more complex an international transaction is, it’s often very hard to say what the place of it is,” Norton Rose Fulbright US LLP attorney Robert Schwinger said.
With blockchain, “when the thing is passing through many, many nodes of computers all around the world, it’s vastly 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 it was 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 purchaser’s location at the time of transaction. In Utah, a district court found transactions in securities sold over the internet occur in both the seller’s and buyer’s locations.
“There are at least differences in nuance in the existing case law about trying to figure out where irrevocable liability is incurred between the buyer and the seller in a blockchain transaction,” Richman said. “This is 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 what matters may be the location of the first node that verified the transaction, as that is what makes the transaction binding. Such a test “appears to be administrable” and follows precedent, he said.
Questions about what the right approach is something that is expected to continue to be litigated.
“I see this coming up more often as we have an increasing number of private claims being made,” University of Arkansas law professor Carol Rose Goforth said.
An advantage of a first node test is that it’s simple, said Samuel Dibble, an attorney at Baker Botts LLP, although it’s not clear it can fit all blockchain transactions. The simplicity of the test has the potential to create problems.
“People will try to evade the jurisdiction of the United States by directing traffic outside for the first node verification,” Indiana University law professor Sarah Hughes said.
Investors sued Block.one in 2020, alleging the firm defrauded them “through a year-long illegal 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’ suit is “without merit” and “filled with numerous inaccuracies.”
An inability by crypto investors to link transactions to the US can be a reason for courts to dismiss a lawsuit. Block.one’s case highlights how the question can raise issues at other stages of litigation—and get in the way of a settlement.
Kaplan worried Crypto Assets may have an incentive to accept a lower settlement offer than would’ve been demanded by investors who engaged primarily in US transactions. He noted the deal was 75% less than the total alleged loss “largely because of the presence of foreign purchases.”
The judge said he “implies no misconduct or criticism of the Lead Plaintiff or its experienced and well regarded Lead Counsel.” Rather, this was “a structural problem having roots in the unusual market that the case concerns.”
There could be solutions to this type of problem, attorneys say. On Monday, an individual who said nearly all of his token purchases were domestic asked to be substituted as lead plaintiff in the litigation.
Still, Kaplan’s ruling is “definitely a warning that [these cases] are complicated,” Richman said.