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April 8, 2020

Investor Class Action Securities Lawsuits—The Next Big Thing In Cryptocurrency Litigation?

By Matthew G. Lindenbaum, Robert L. Lindholm, Caroline Colpoys

On Monday, April 6, two law firms filed 11 class action lawsuits in the Southern District of New York on behalf of investors against four cryptocurrency exchanges and seven digital token issuers, alleging the illegal sale of billions of dollars’ worth of unregistered digital tokens.   Plaintiffs allege that Defendants’ offer and sale of the digital tokens was an offer and sale of unregistered securities in violation of federal and state securities laws. While there have been a few one-off cases over the past few years making similar allegations, this is the first investor-driven coordinated effort to attack cryptocurrency exchanges and token issuers. 

Plaintiffs’ claims and alleged theories are almost identical to claims and theories the SEC has pursued in actions against digital token issuers over the past few years. The defendants face claims that they offered and sold unregistered securities, and the exchanges also face claims that they operated as unregistered broker-dealers.  In their actions against the exchanges, Plaintiffs allege that prior to the SEC’s April 3, 2019 “Framework for ‘Investment Contract’ Analysis of Digital Assets,” Plaintiffs would not have known that the tokens listed on the exchanges qualified as securities. According to the Plaintiffs, exchanges “profited handsomely from [the] listing of new tokens on [their] platform. In addition to receiving fees for each transaction performed on its exchange, [the exchanges] received large cash payments from Issuers seeking to get their tokens listed.”  

In their lawsuits against the digital token issuers, Plaintiffs utilize the Supreme Court’s Howey test to argue that the tokens offered actually qualified as securities. Plaintiffs allege that while offerors informed investors that the tokens were utility tokens or informed offerors in their white paper that the tokens were not securities, the tokens are actually securities “because they constituted an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” In addition, Plaintiffs also reference the SEC’s September 2019 settlement with Block.One, where the SEC concluded had violated the Securities Act by selling the digital token EOS, an unregistered security, to the public. Plaintiffs allege that this finding “applies with equal force to other tokens,” including the tokens at issue in the complaints.    

In its action against BitMEX, Plaintiff alleges that BitMEX and its co-founders engaged in market manipulation in violation of the Commodities Exchange Act (“CEA”) by manipulating the prices on BitMEX by conducting automatic liquidations and manipulating the prices of the digital assets underlying its derivative products.  BitMEX and its cofounders are the only defendants facing these charges at this time.

The lawsuits raise a number of procedural and substantive issues. For example, will the 11 lawsuits go to 11 different judges in the SDNY or will they all be assigned to one or two judges, decreasing the possibility of inconsistent decisions? Will these 11 lawsuits be the tip of the iceberg with more to follow from these two law firms or other law firms in light of the billions of dollars raised through hundreds of ICOs and token sales? How much weight will the SEC’s settlements with various digital token issuers carry with the courts? Only time will tell, but we think the filing of these lawsuits is more likely to be a trend rather than a one-off event and may be the next big legal issue the cryptocurrency industry has to deal with.   

Nelson Mullins can help companies and investors navigate the evolving ICO, cryptocurrency, and blockchain regulatory and legal environment.  The White Collar Defense and Government Investigations Group has extensive experience responding to regulator inquiries and other government investigations, as well as representing clients in related civil litigation, including class action lawsuits.  The firm’s Blockchain and Digital Currency Group and Securities and Enforcement Practice are also available to advise ICO issuers, exchanges, investors, and institutional investors on how to comply with SEC and other governmental agency registration requirements and regulations.

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