Fraud and other malfeasance in Initial Coin Offerings (ICOs) and other digital asset investments continue to present a significant issue for investors. In the first half of 2019, it was estimated that “exit scams” resulting in lost digital tokens cost investors approximately $3.1 billion alone. This is in addition to the billions lost by investors that participated in legitimate ICOs, and in addition to the billions lost by investors that have purchased secondary market digital assets.
But investors are not without recourse when a digital asset-related project turns out not to be what it seems. Through private litigation, and regulatory action, investors have been seeking recovery for their losses–and the United States Securities and Exchange Commission (SEC) has started actively policing the space.
If your fund has suffered losses in a digital asset investment, the developments in this space are relevant to you. Thousands of digital assets started trading in the past couple of years, and regulatory and judicial guidance has shown that the facts of each asset and each investment can be critical. If your fund has suffered losses, there may be avenues of recovery–but those roads are closing as a result of statutes of limitations.
Update on Private Litigants Seeking Recovery
Private litigants seeking recovery for their digital asset losses have had a number of valuable claims in their arsenal–but cases demonstrate that the door for recovery is closing fast.
- Actions against ICO issuers over unregistered securities continue.
Continuing a trend that started last year, class actions continue to be filed against digital asset issuers where the digital asset itself may be a security under U.S. securities laws, and thus requires registration under the 1933 Securities Act. For example, a class action is pending against Ripple Labs (Ripple) alleging that XRP is a security and therefore an unregistered offering in violation of the securities laws. The complaint also alleges that unlike Bitcoin and Ethereum, which were mined by validating transactions on their networks, all 100 billion XRP were created “out of thin air” by Ripple. On Sept. 20, Ripple filed a motion to dismiss the complaint. (Ripple Labs Inc. Litigation, 4:18-cv-06753, (N.D. Cal.)). If successful, investor-plaintiffs in such cases can receive rescission of their transactions and potentially recover the full amount of their original investment.
- Investors cannot sleep on their rights.
Other recent cases have shown that investors cannot afford to sleep on their rights. In Fabian v. Nano fka Raiblocks fka Hieusys LLC. et al., No. 4:19-cv-00054 (N.D. Cal.), a case concerning digital asset NANO, plaintiffs alleged that Nano, which promoted and sold its product over Reddit and Twitter without registering with the SEC, is responsible for the disappearance of $170 million worth of its currency. On Oct. 7, the Northern District of California dismissed plaintiffs’ federal securities claims as untimely, but allowed its fraud and negligence state law claims to proceed.
Investors that act quickly can avoid the diminution and eventual elimination of their claims.
- Investors cannot assume a class action will vindicate their rights.
Investors in the public securities markets often rely on class actions to bring them at least some recovery resulting from corporate fraud. While this is a dangerous assumption with respect to the well-developed area of public market securities litigation, it is particularly dangerous with respect to the nascent world of digital asset recovery.
Recent developments in the case Rensel et al. v. Centra Tech, Inc., No. 1:17–CV-24500 (S.D. Fla.) show why. On Sept. 17, the Southern District of Florida denied class certification in a $32 million lawsuit based on Centra Tech’s allegedly fraudulent ICO. Plaintiffs filed a default judgment and a motion for class certification against Centra Tech. The court held plaintiffs’ motion for class cert was time-barred and that the class is unascertainable in any event. Plaintiffs’ contention that the class can be readily identified through defendant’s purported “spreadsheet” of digital asset purchases was rejected by the court.
Investors defrauded by Centra Tech may be facing the real possibility of getting no recovery at all unless they take independent action.
What can my fund do if we engage in digital asset investments?
For institutional investors that have already invested in digital assets, it is a critical time to review those investments and consider whether they may have been sold in violation of the securities laws. Where that is the case, institutional investors may have a variety of remedies to recover their losses. Section 12(a)(1) of the securities laws, for example, provides a rescission remedy, which may allow your fund to recover the monies lost in the investment. State blue sky laws, common law fraud causes of action, and other claims can also allow for damages, depending on the facts of the case.
For institutional investors that participated in ICOs or purchased digital assets and suffered losses, time is of the essence. Actions under 12(a)(1), i.e., lawsuits alleging that an ICO sold an investor unregistered securities, allowing for the possibility of rescission, must be brought within one year of the offering. While certain tolling rules can extend this time in select cases, investors cannot afford to sleep on their rights.
Even if a year has already elapsed, other claims may exist that can still result in a recovery for your fund. Only a review of your fund’s digital asset trading can provide a clearer picture of your claims and potential remedies.
If you are considering an investment in an ICO, whether as an initial sponsor or as a purchaser, we recommend you consider seeking counsel either before making the investment or as soon thereafter as practicable. By analyzing the facts of the token or coin at issue, we can assist you in protecting the full gamut of your rights.
Lowenstein Sandler’s Securities Litigation Group has extensive experience recovering losses, and creating value, for institutional investors across their full range of investments. Whether bringing direct action securities fraud cases against bad actors, defending investors’ rights in debt or appraisal proceedings, or reviewing new investments such as digital assets, Lowenstein Sandler brings immediate value to investors’ bottom line.
For more information, and for a no-fee review of your digital asset portfolio, please contact the authors of this alert.