Category Archives: Securities

Motion to Dismiss in the Tezos ICO Litigation – Key Takeaways for Plaintiffs’ Attorneys

Judge Richard Seeborg recently issued one of the first judicial opinions grappling with the thorny issues faced by plaintiffs attempting to hold Initial Coin Offering (”ICO”) sellers and promoters liable under US laws. In re Tezos Securities Litig., 17-CV-06779-RS (N.D. Cal), ECF No. 148. Plaintiffs alleged that the Tezos cryptocurrency “token” was an unregistered security sold in violation of sections 12 and 15 of the Securities Exchange Act of 1934 and therefore the sale could be rescinded. In partially denying the motion to dismiss, Judge Seeborg provided guidance for those seeking redress on behalf of defrauded ICO investors.

To begin with, the Court confronted one of the biggest questions surrounding ICO litigation: Can plaintiffs sue sellers in US courts? Judge Seeborg found that personal jurisdiction existed over the Tezos Foundation (purportedly an independent non-profit organized under Swiss law) which “sold” the tokens. The Court pointed to four factors influencing this decision: “(a) the Foundation kept at least one employee or agent in the United States; (b) the California-based creators were the de facto U.S. marketing arm of the Foundation; (c) the Foundation engaged in little to no marketing of the ICO anywhere other than in the U.S.; and (d) an accordingly significant portion of the some 30,000 contributors to the ICO were in fact U.S. citizens.” In addition, the Court highlighted that the Foundation used an “English-language, U.S.-hosted website” and “structure[d]” the ICO in a way to accommodate U.S.-based participation. While an especially diligent seller could have avoided some of these ties to the US, simply locating your foundation in Switzerland is not enough to avoid personal jurisdiction if your foundation’s actions are directed by – and targeted at – US citizens. If you sell tokens to US citizens, you are likely subject to US securities laws.

The Court followed similar logic in denying the Tezos Foundation’s effort to skirt liability by arguing that the sale did not occur within the US, but rather in Alderney (a remote outpost of the British Crown specified as the legal site of all transactions). While acknowledging that the Contribution Terms associated with the sale might eventually govern, the Court found that at this juncture the actual (rather than contractual) situs of the ICO transaction took precedence. The Court found that the Plaintiffs sufficiently alleged the purchase occurred inside the US. Lead Plaintiff participated in the ICO transaction from the US, relied upon marketing that almost exclusively targeted US residents, used a website hosted in Arizona, and engaged with an overall scheme orchestrated in California.

Next, the Court made short work of Tezos’ argument that any suit against the Foundation must be brought in Switzerland. The Foundation argued that Plaintiffs were bound by a set of Contribution Terms on the Tezos website, including a forum selection clause stating that disputes must be adjudicated in Switzerland. While the Court acknowledged that the Tezos Foundation’s argument was “a strong one” that might eventually require dismissal or transfer if such terms were found to be binding, it found insufficient evidence that the forum selection clause controlled. The Court analogized the Tezos Contribution Terms to “browserwrap” agreements (website terms and conditions that purport to bind users by inferring affirmative assent) as opposed to “clickwrap” agreements that require users to “specifically engage with the website – generally by checking a box – in a show of contractual consent.” Because Defendants were unable to show that the Lead Plaintiff had acknowledged or even reviewed the Contribution Terms, the Court held that Plaintiffs sufficiently alleged a purchase process where a reasonably prudent user would not have suspected the Contribution Terms governed.

Whether and to what extent the various contribution terms associated with ICOs are binding is a major unresolved question for plaintiffs’ attorneys. Many ICOs inserted onerous forum selection clauses or binding arbitration provisions to avoid US courts. Judge Seeborg, at least, was not inclined to give Defendants the benefit of the doubt on this front. In addition, the very nature of these token sales (which frequently could be consummated solely on the Blockchain without the type of affirmative consent required by Judge Seeborg) creates doubt about just how effective these protections will be for ICO defendants.

Another question facing plaintiffs is exactly who can be held liable for ICO token sales. Judge Seeborg addressed this question in two contexts. First, the suit named Tim Draper, a venture capitalist (“VC”) and early investor in Tezos. The Court dismissed claims against Draper finding that liability as a “statutory seller” under Pinter v. Dahl, 486 U.S. 622, 643-647 (1988), requires a defendant to be directly involved in the actual solicitation of a securities purchase. Lead Plaintiff was unable to allege that he was even aware of Draper’s existence. The Court also found that Draper could not be considered a “control person” since Plaintiffs failed to allege that Draper had “daily or overall participation in the Tezos project or corporate entities.” Presumably, efforts to hold VCs liable for their participation in ICOs will require more than them simply lending their name and credibility to a project. VCs who actively participate in either the management or marketing of the ICO may be on shakier ground.

Next, the Court addressed whether DLS – a US company involved in the creation of the project and owned by the two main individuals driving the Tezos project – could be held liable. In this instance, the Court found that DLS was subject to liability as a “statutory seller” even though it was the Tezos Foundation that was the titular “seller.” Pointing to Plaintiffs’ factual allegations regarding DLS’s comprehensive involvement in the ICO’s planning and execution, the Court ultimately found that DLS and the Tezos Foundation were “deeply intertwined, if not functionally interchangeable.” Allegations supporting this conclusion included DLS’s “creation of the Tezos technology, establishment of a legal entity to monetize DLS’ interest in that technology, development of a platform to facilitate said monetization, and minute-to-minute oversight of the monetization process itself.” As a result the Court found that DLS was more than a “collateral participant” in the ICO and could be considered a “statutory seller” under Pinter.


Overall, the Tezos opinion demonstrates just how crucial the specific facts and circumstances of an ICO sale will be in resolving questions of ICO liability under US laws. Given how perfunctory the Tezos Defendants’ attempts were to avoid being subject to US securities laws, Judge Seeborg’s decision is maybe not surprising. At a minimum, it should be a warning to future ICO promotors to avoid using US-based resources to solicit US customers.

The opinion also reinforces the importance of the various terms and conditions ICO promoters attempted to impose on token purchasers. How effective these terms ultimately may be is still unknown, but Judge Seeborg’s opinion indicates that absent clear and unambiguous consent, such terms may not fly in the ICO context. A similar issue, with the same result, has arisen in litigation over the Centra ICO. Because the Centra Defendants were unable to unambiguously prove that the purchaser agreed to the binding arbitration clause found in the Token Sale Agreement, the Defendants’ motion to compel arbitration was denied.

Judge Seeborg’s opinion is an encouraging sign for aggrieved ICO investors. Judge Seeborg seemed unwilling to give much weight to Defendants’ efforts to sidestep liability through the invocation of legal technicalities without supporting facts. Plaintiffs alleged that the planning and execution of the ICO occurred largely within the US and that the sale of Tezos tokens was primarily directed at US purchasers. One of the biggest questions facing aggrieved ICO investors has been whether courts will uphold the spirit of the law in the face of the numerous legal hurdles ICO sellers and promoters have attempted to erect. Judge Seeborg, at least, was unwilling to let Defendants off the hook at an early stage simply because the sellers claimed they were not selling a security in the US and thus not subject to US jurisdiction. The opinion confirms what a number of ICO skeptics have been saying: if it looks like a security and acts like a security, then it is probably a security.

Supreme Court to Revisit Extent of Class-Action Tolling

IndyMacOn March 10th, the U.S. Supreme Court agreed to consider whether the three-year window for filing a securities claim is suspended if investors can prove that they would have been plaintiffs in a previous class action, had it not been dismissed. The case at issue in front of the Court is Public Employees’ Retirement System of Mississippi v. IndyMac MSB Inc., et. al., a mortgage-backed securities class action.

Plaintiffs brought the putative class action in 2009, alleging that IndyMac sold certificates backed by bad residential mortgage loans. However, after appointing the Wyoming Retirement System as the lead plaintiff, the court ruled in 2010 that the Retirement System lacked standing to bring certain claims. Accordingly, the Public Employees’ Retirement System of Mississippi (MissPERS) and others sought to intervene to take its place. MissPERS’s request for intervention, however, was denied by the trial court because more than three years had by then passed since the certificates were issued.

MissPERS appealed the decision, citing American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974). American Pipe held that the commencement of the original class suit tolls the running of the statute of limitations for all purported class members who make timely motions to intervene. This tolling doctrine was designed to keep identical lawsuits from clogging the courts. American Pipe has been applied in countless class actions as an accepted practice to ensure that absent class members have fair opportunities to litigate their claims.

Despite the historical precedent–and the Supreme Court’s explicit instruction that the pendency of a class action tolls the statute of limitations until class certification has been denied–the U.S. Court of Appeals for the Second Circuit upheld the lower court’s ruling. According to the Second Circuit, the Rules Enabling Act provides that the Federal Rules of Civil Procedure, “shall not abridge, enlarge or modify any substantive right,” and forbids interpreting Rule 23 as tolling a statute of repose.

The Second Circuit’s ruling is important for a number of reasons. First, that circuit hears the lion’s share of securities class actions–nearly double the number of such cases at the next highest circuit. With more than 200 securities class actions filed in the Second Circuit each year, there are hundreds of thousands, if not millions, of investor claims at stake here, along with more than $200 billion in losses.

Second, defendants in securities class actions will likely urge other courts to adopt the Second Circuit’s reasoning, and should that happen, investors will have to act preemptively and start filing their own individual suits or motions to intervene in the event that a court denies certification and the “repose” period has expired. This behavior, in turn, will flood the federal and state courts with protective suits and motions, which is precisely the situation the Court sought to avoid with American Pipe.

And third, one of the main purposes of class action litigation is to enable the pooling of resources to make it cost-effective to hold defendants accountable. Failing to permit tolling will either increase individual costs or impede the litigation of worthy claims because plaintiffs won’t be able to rely on other plaintiffs to represent their interests.

The Supreme Court will hear oral arguments and issue a decision in its next term, which begins in October and ends in June 2015.

–Mary Ellen Egan


FINRA Gets Tougher On Brokers Seeking Expungements

BrokerIt may soon be harder for brokers and financial advisers in the securities industry to scrub their records of investors’ complaints from their disciplinary records.

Last month, the Financial Industry Regulatory Authority (FINRA) approved a rule that will prevent brokers and advisors from “conditioning settlements of customer disputes on, or otherwise compensating customers for, an agreement not to oppose a request to expunge information” from a broker’s or financial adviser’s records.

FINRA, a nonprofit charged by Congress to regulate the securities industry, maintains a database that contains information on brokers including customer complaints, regulatory actions and brokers’ criminal histories, liens and bankruptcies.

The veracity of the broker database is critical for investors. A 1987 Supreme Court decision allows brokerage firms to insist that customers forfeit their right to sue in court. Should a dispute arise, customers are forced into arbitration. And since arbitration hearings are closed and the documents are not made public, the BrokerCheck database is the only tool an investor has to vet a broker or financial adviser.

The proposed rule change was spurred by critics, including investors and the plaintiffs’ bar, who contend that some brokers are simply buying a clean record by offering compensation in return for customers agreeing not to oppose an expungement request.

The Public Investors Arbitration Bar Association (PIABA), which represents investors in arbitration cases, published a study last October that revealed that brokers are able to obtain expungement in about nine out of ten cases resolved by settlement or a stipulated award. Between January 2007 and May 2009, expungement was granted 89% of the time in cases resolved by stipulated awards or settlement, and 96.9% of the time between May 2009 and December 2011, according to the study.

Korein Tillery attorney George Zelcs noted: “Investors are clearly entitled to this valuable information about their brokers. This rule change is long overdue.”

The new rule is at the U.S. Securities and Exchange Commission (SEC) for further review, and will be open for public comment before a final decision is made.

-Mary Ellen Egan