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Crypto Litigation and Regulation Reporter: September 2022

September 02, 2022
Business Litigation Reports

In this issue

  • Securities and Exchange Commission v. Ishan Wahi, Nikhil Wahi, and Sameer Ramani (W.D. Wash., July 21, 2022) and United States v. Ishan Wahi, Nikhil Wahi, and Sameer Ramani, Indictment (S.D.N.Y., July 21, 2022) 
  • Terra/Luna Class Action Lawsuits 
  • Audet v. Fraser, 3:16-cv-940 (MPS), 2022 WL 1912866 (D. Conn., June 3, 2022)
  • In re Voyager Digital Holdings, Inc., 22-10943 (Bankr. S.D.N.Y., July 5, 2022)
  • In re Celsius Network LLC, 22-10964 (Bankr. S.D.N.Y., July 13, 2022)
  • United States v. Thompson, CR19-159-RSL, 2022 WL 2064854 (W.D. Wash., June 8, 2022)
  • Order to Show Cause and Temporary Restraining Order, LCX AG v. John Does No. 1-25,  154644/2022 (N.Y. Sup. Ct., June 2, 2022)
  • ForUsAll, v. Dep’t of Labor, No. 1-22-cv-01551 (D.D.C., June 2, 2022)
  • Grayscale Investments, LLC v. SEC, No. 22-1142 (D.C. Cir. June 29, 2022)

Securities and Exchange Commission v. Ishan Wahi, Nikhil Wahi, and Sameer Ramani
(W.D. Wash., July 21, 2022) -and- United States v. Ishan Wahi, Nikhil Wahi, and Sameer Ramani, Indictment (S.D.N.Y., July 21, 2022):

In July, the Securities and Exchange Commission announced insider trading charges against Ishan Wahi, a former product manager at Coinbase Global, Inc. (“Coinbase”).  Also named in the complaint were Wahi’s brother, Nikhil Wahi, and his friend, Sameer Ramani.  In a parallel action, the United States Attorney for the Southern District of New York jointly announced with the FBI the unsealing of an indictment charging the same three defendants with wire fraud conspiracy and wire fraud in connection with the insider trading scheme.  This marks the first time that insider trading charges have been brought in connection with cryptocurrency markets. 

The SEC Complaint alleges that while employed by Coinbase, Wahi was involved in the highly confidential process of listing new assets on the Coinbase exchange.  Accordingly, the complaint alleges, Wahi had advance knowledge of which crypto assets Coinbase was planning to list, as well as the timing of Coinbase’s public announcements regarding these assets.  The complaint further alleges that Wahi fed this confidential information to his brother and friend, who used multiple anonymous Ethereum wallets to purchase large quantities of the assets before they were listed on Coinbase’s exchange.  The complaint alleges that Nikhil Wahi and Ramani traded in advance of at least 14 separate Coinbase public listing announcements concerning at least 25 different assets, collectively realizing approximately $1.5 million. 

On August 3, 2022, the Wahi brothers appeared in Manhattan before District Judge Loretta Preska and pleaded not guilty to the wire fraud and conspiracy charges.  The brothers dispute that the assets at issue constitute securities or commodities, teeing up a fight with the SEC over the extent of their jurisdiction and enforcement capabilities in regulating cryptocurrency markets. 

Terra/Luna Class Action Lawsuits

Several cases have been filed related to the implosion of the Terra/Luna tokens.

  • Albright v. Terraform Labs, No. 1:22-cv-07281 (S.D.N.Y., Aug. 25, 2022) – This putative class action, filed on behalf of all persons and entities who purchased Terra USD (“UST”) between May 1, 2019 and June 15, 2022, alleges that Terraform Labs (“Terraform”) violated the Racketeer Influenced and Corrupt Organizations Act (“RICO”). The complaint alleges that executives at Terraform, which operates the Terra blockchain and its related protocol, engaged in a money laundering scheme to siphon millions of dollars into their personal wallets, and that the Terra USD stablecoin was a cleverly designed Ponzi scheme meant to defraud investors.  The civil RICO action also names as codefendants Delaware-based Jump Crypto and Jump Trading, Terraform’s Head of Research Nicholas Platias, Terraform’s CEO Do Kwon, and various financial backers.   
  • Patterson v. Terraforms Labs, No. 3:22-cv-03600 (N.D. Cal., June 17, 2022) – A putative class action was similarly filed against Terraform in the Northern District of California. The complaint alleges that Terraform sold UST, Luna, and other digital assets (“Terra Tokens”) in violation of federal securities laws, and that Terraform and related entities behind the Terra Tokens made untrue statements of material fact about the digital assets in violation of SEC Rule 10b-5, which identifies and prohibits manipulative and deceptive practices in connection with a security exchange.  Further, the complaint alleges that Terra Tokens are securities that are not registered with the SEC, and that Terraform is therefore an illegal, unregistered broker or dealer under the Securities Exchange Act of 1934.  The complaint also brings claims under California common law against myriad related defendants (collectively the “Luna Foundation Guard”).  The plaintiffs allege that the Luna Foundation Guard and named defendants knew or should have known that TerraForm marketed the Tera Tokens in an unlawful manner and thus aided and abetted in TerraForm’s purportedly unlawful conduct.  Taken together, plaintiffs allege, this conduct amounts to a conspiracy to “misleadingly promote the Terra Tokens.”

Lockhart v. BAM Trading Servs., Inc., No. 3:22-cv-034610 (N.D. Cal., June 13, 2022) – This putative class action against Binance and BAM Trading Services, Binance’s partner for its U.S.-based exchange, similarly arises out of the May 2022 crash of the UST stablecoin and Luna token.  UST, which aspired to maintain a $1 USD peg, is now valued at less than one cent per coin.  The putative class purports to represent all persons nationwide who transacted in UST on the Binance platform.  The complaint alleges that Terra USD and its sister cryptocurrency, Luna, are securities under the Howey test, and that Binance violated federal securities law by listing and selling the cryptocurrencies on its exchange, acting as an unregistered broker-dealer in violation of the Securities Exchange Act of 1934. 

Audet v. Fraser,
No. 3:16-cv-940 (MPS), 2022 WL 1912866 (D. Conn., June 3, 2022):

Following a jury verdict declaring that a cryptocurrency, Paycoin, and several related digital products were not securities under the Howey test, the U.S. District Court for the District of Connecticut (Judge Michael Shea) granted plaintiff’s Rule 59 motion for a new trial solely on the question of whether a cryptocurrency token, Paycoin, constituted an “investment contract.”  

Plaintiffs—investors in Paycoin and three related products called Hashlets, Hashpoints, and Hashstakers—filed a putative class action asserting various theories of liability under securities statutes and common law fraud doctrines related to the sale of various digital asset products. These products include Paycoin, a cryptocurrency, and related assets that allow investors to purchase a stake in products used to mine and store Paycoin.  Before trial, Judge Shea declined to rule as a matter of law as to whether any of the products were securities.  At trial, the jury concluded that none of the four products at issue were investment contracts under SEC v. W.J. Howey Co., which instructs that an investment contract (and therefore a security) exists when there is “(1) an investment of money (2) in a common enterprise (3) with profits to be derived solely from the efforts of others.”

Following the jury verdict, plaintiffs moved for a new trial, arguing that the jury’s finding that Paycoin and the related products were not investment contracts was against the weight of the evidence.  Judge Shea upheld the jury’s findings with respect to the related products, noting that these assets did not necessarily tie the fortune of one investor to the fortunes of others and that they functioned more like “in-house credit” than securities.  On the question of Paycoin, however, the court determined that the weight of the evidence did not support a finding that the cryptocurrency was not a security.  Instead, Judge Shea noted that Paycoin necessarily satisfied the “common enterprise” and “efforts of others” prongs of the Howey test, and accordingly granted a new trial to determine whether Paycoin is an investment contract.

In re Voyager Digital Holdings, Inc.
, No. 22-10943 (Bankr. S.D.N.Y., July 5, 2022):

Voyager Digital Holdings (“Voyager”), a cryptocurrency brokerage that also provides in-platform custodial services for its customers, filed a Chapter 11 bankruptcy petition in the U.S. District Court for the Southern District of New York.  Voyager’s model allows customers to store and earn interest on their cryptocurrency holdings kept on the platform without using an outside wallet.  Citing a “run on the bank” in light of falling cryptocurrency values and rapid inflation, Voyager seeks relief to “maximize the value of its business and allow customers to fully use the company’s platform.”  The filing notes that Voyager faced great exposure from the Luna token collapse and the fact that Voyager had made a loan of 15,250 Bitcoin and 350 million USDC to Three Arrows Capital, a Singaporean crypto hedge fund that recently initiated liquidation proceedings due to the collapse of the Luna token.

In re Celsius Network LLC
, No. 22-10964 (Bankr. S.D.N.Y., July 13, 2022): 

On the heels of Voyager’s bankruptcy filing, Celsius Network (“Celsius”) also filed for Chapter 11 bankruptcy.  The Celsius platform allows customers to transfer ownership of their cryptocurrencies to Celsius, where customers can then borrow fiat currency or other digital assets, earn rewards on their cryptocurrency, or even establish loans by pledging their cryptocurrency as security.  As cryptocurrency withdrawals on the Celsius platform mounted following Terra’s collapse, Celsius paused all withdrawals on the platform on June 12, 2022, filing for bankruptcy one month later.  At the time of the bankruptcy filing on July 13th, Celsius still had not unfrozen the assets on its platform.  On August 17, 2022, Chief Judge Martin Glenn authorized Celsius to sell some of its mined Bitcoin to help support is continued business operations during the pendency of the Chapter 11 proceedings, and the CFO of Celsius, Chris Ferraro, later stated in a call with creditors that the company is expected to be able to fund its operations until the end of the year.  To date, two adversary complaints—seeking to force various third parties to turnover allegedly stolen digital assets to Celsius—have also been filed and are pending before Judge Glenn. 

United States v. Thompson
, No. CR19-159-RSL, 2022 WL 2064854 (W.D. Wash., June 8, 2022):

 In response to a pre-trial motion in limine filed by defendant, Judge Robert Lasnik of the U.S. District Court for the Western District of Washington considered whether the Government could refer to defendant’s cryptomining activities as “cryptojacking” and “hacking.”  The indictment alleged that the defendant used proxy scanners to identify Amazon web applications with misconfigured firewalls, allowing the defendant to obtain security credentials for associated servers.  Allegedly, the defendant used these credentials to copy users’ stored data and set up cryptocurrency mining operations on the servers.  At various times, the defendant herself referred to these activities as “cryptojacking.”

The defendant’s motion sought to bar the government from referring to these activities as “cryptojacking” because of pejorative nature of the term “jacking” and its association with activities like “carjacking” and “hijacking.”  The defendant instead requested that the prosecution refer to the activities as “cryptomining.”  The defendant also challenged the use of the phrase “hacking,” arguing that the term has a negative connotation that the public associates with illegal activity, while the cybersecurity community views the term as neutral and encompassing both legal “white hat” hacking” and illegal “black hat” hacking. 

Judge Lasnik denied the defendant’s motion as to each of these requests, concluding that the Government could use both “cryptojacking” and “hacking” at trial because of defendant’s own use of the term “cryptojacking” to describe her activities, and because of their prevalence in the record and in proceedings under the Computer Fraud and Abuse Act more generally.  However, the court reserved a decision on the issue of whether to submit a jury instruction about the purportedly neutral connotation of the term “hacking.”

Order to Show Cause and Temporary Restraining Order, LCX AG v. John Does No. 1-25, No. 154644/2022 (N.Y. Sup. Ct., June 2, 2022):

In this case pending before a New York state trial court, Justice Andrea Masley ordered that service of a court proceeding and a temporary restraining order could be accomplished via airdrops of a special-purpose Ethereum-based token into the defendants’ crypto wallet.  This appears to be the first time that a court has endorsed service of process using blockchain technologies.

The plaintiff, LCX, is a fintech company and cryptocurrency exchange.  The complaint alleges that each unnamed defendant gained unauthorized access to the exchange and stole about $8 million worth of digital assets.  The complaint further alleges that the hackers purchased USD Coin with scrambled versions of the stolen assets and stored the USD Coin assets on a known wallet.  While some of the purchased USD Coin assets have since been sold off, the plaintiff sought a preliminary injunction against future sales of the remaining assets in the wallet.

Justice Masley ordered the defendants to show cause at a preliminary injunction hearing and granted a temporary restraining order against selling the assets until the hearing date.  Because the defendants could only be located through their wallet address, Judge Masley permitted LCX’s attorneys to serve a copy of the order and the preceding papers via a blockchain token that could be airdropped to the wallet, explaining that using a program—such as airdropping—that tracks when a person receives and opens the papers that have been served upon them “shall constitute good and sufficient service for the purposes of jurisdiction under NY law.”

ForUsAll, Inc. v. Dep’t of Labor,
No. 1-22-cv-01551 (D.D.C., June 2, 2022):

This complaint challenges guidance issued by the Department of Labor (“DOL”) titled “401(k) Plan Investments in ‘Cryptocurrencies’” (the “Release”) which put in place stringent guidelines for plan fiduciaries to follow before adding a cryptocurrency option to their 401(k) plan investment menus. 

Specifically, the complaint accuses DOL and Secretary of Labor Martin Walsh of violating the Administrative Procedure Act (“APA”) by issuing the Release without following a period of notice and comment.   Plaintiffs allege that DOL acted arbitrarily and capriciously by circumventing the notice and comment period—in violation of the APA—and instead issuing the Release expediently, citing concerns about the volatility of cryptocurrency. 

Plaintiff, a company that provides 401(k) plans and administrative support to startups and small businesses, alleges that the guidance will constrain their ability—and that of American investors—to choose how to invest money in their own retirement accounts.  The complaint explains that fiduciaries are already required to ensure that an investment is “prudent and made solely in the interests of the plan’s participants and beneficiaries,” and argues that DOL should not be in the business of making comparative decisions of prudence between different types of investments.

Grayscale Investments, LLC v. SEC
, No. 22-1142 (D.C. Cir. June 29, 2022)

Over the past year, the SEC has repeatedly rejected requests from investment firms seeking to list and trade spot bitcoin exchange-traded funds (ETFs) on regulated exchanges – while simultaneous approving several bitcoin futures ETFs.  In June, Grayscale Investments, LLC became the first firm to appeal the SEC’s denial of its application to create a spot bitcoin ETF.  See Petition for Review, Grayscale Investments, LLC v. SEC, No. 22-1142 (D.C. Cir. June 29, 2022).  Earlier this week, the D.C. Circuit granted Grayscale’s request for an extension of time to file its initial briefing, with Grayscale’s opening brief now due on October 11, 2022.  Among other things, Grayscale is likely to argue that the SEC’s relatively favorable treatment of similar investment vehicles (such as bitcoin futures ETFs) renders the Commission’s denial of Grayscale’s application arbitrary and capricious under the Administrative Procedure Act.  This is the first time that a firm has challenged the SEC’s rulemaking on this issue, and will be a case to watch as briefing unfolds.