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Judge Hears Debate on Legal Questions of Cryptocurrency

Wading into uncharted territory, a federal judge hinted Wednesday that he may advance a class action seeking to hold the creators of a new cryptocurrency liable for violating U.S. securities laws.

SAN FRANCISCO (CN) – Wading into uncharted territory, a federal judge hinted Wednesday that he may advance a class action seeking to hold the creators of a new cryptocurrency liable for violating U.S. securities laws.

In one of the first lawsuits to claim cryptocurrency tokens are investments subject to U.S. securities laws, investors say a married couple and Swiss foundation are liable for damages relating to a July 2017 initial coin offering that raised $232 million for a new digital currency called Tezos.

The defendants include Arthur and Kathleen Brietman, the married couple who developed the new cryptocurrency; their Delaware-based company Dynamic Ledger Solutions, which controls the source code for Tezos; Tezos Stiftung, a Swiss nonprofit that handled transactions for the initial coin offering; and Tim Draper, a venture capitalist who controls 10 percent of Dynamic Ledger Solutions, among other defendants.

Four class actions were filed and later consolidated after an internal dispute delayed the launch of the new Tezos blockchain, a supposedly advanced system for securely exchanging Tezos tokens through a digital network.

The defendants say the initial coin offering was merely a fundraiser, not an investment scheme, and that they have no obligation to provide Tezos tokens to contributors. The plaintiffs say the contributions were investments, which means the defendants were required to register with the U.S. Securities and Exchange Commission before accepting money.

During a motion to dismiss hearing Wednesday, U.S. District Judge Richard Seeborg appeared skeptical of arguments that the Breitmans are shielded from liability because the initial coin offering transactions were handled by Tezos Stiftung, a separate Swiss entity launched by Breitmans.

"They were the brains behind the whole concept," Seeborg said of the Breitmans. "We then find a Swiss foundation doing the actual activity, and I'm supposed to put blinders on and look at these entities as completely separate."

Still, the judge voiced concern that the plaintiffs failed to articulate a coherent legal theory, such as alter ego, to show how the Breitmans, their Delaware-registered corporation and the Swiss foundation are connected.

Plaintiffs' New York-based attorney Hung Ta told Seeborg the Breitmans acted as "agents" and actively marketed and promoted the initial coin offering, meaning they can be held liable for solicitation.

The Breitmans' attorney Brian Klein, of Baker Marquart in Los Angeles, said his clients never "urged” anyone to contribute and therefore could not be accused of soliciting contributions.

"They don't have to use the magic words," Seeborg replied.

Turning to the issue of jurisdiction, a lawyer for Tezos Stiftung argued that U.S. securities laws cannot apply to the transactions because they were handled by a foreign entity and processed by a computer system in Europe.

"The foundation is very clearly in Switzerland," Tezos Stiftung lawyer Neal Potischman said.

But the plaintiffs say that because the defendants actively courted U.S. investors, that makes the transactions subject to U.S. securities laws.

Arguments the Swiss foundation was seeking investments globally, and not specifically from the U.S., drew a few caustic remarks from the judge.

"It's a wing and a prayer," Seeborg quipped. "They hope U.S. donators will come forward, but they're not asking them to do it."

The defendants also argued a forum selection clause in contractual terms for contributions require disputes be handled by Swiss courts. The plaintiffs claim those terms were not made clear and conspicuous to contributors.

During the hearing, Seeborg also suggested he is likely to dismiss Draper, the American venture capitalist. Draper invested $1.5 million in exchange for a board seat and 10 percent ownership stake in the Breitmans' Delaware-based company Dynamic Ledger Solutions.

Seeborg said allowing an investor with a small stake in a company to be sued for securities violations could have ramifications for other investors who make public statements about companies in which they have a financial interest.

"I'm concerned anytime someone makes a public statement about something being sold that's a security, they could be liable," Seeborg said.

After more than two hours of arguments, Seeborg ended the hearing without issuing an official ruling.

In June, Tezos unveiled a test version of its blockchain, or digital exchange system for Tezos tokens, after months of delay.

At close of business Wednesday, a single Tezos unit had a value of $1.98, up about 2 percent but well down from its all-time high of $10.39 in mid-December 2017.

Categories:Courts, Financial, International, Securities

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