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QE on the Block - Digital Assets and Blockchain Newsletter - Spring 2023

May 01, 2023
Business Litigation Reports

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Just Minted: News Sweep Spring 2023

Regulatory Action

  • The SEC issued a Wells notice to crypto leader Coinbase, a preliminary step to bringing a potential enforcement action. According to Coinbase, the SEC believes its Earn, Wallet, and Prime products enable the sale of unregistered securities in violation of federal securities laws. Both Coinbase CEO Brian Armstrong and CLO Paul Grewal have issued statements expressing that the company believes its products are legal and intends to litigate any suit the SEC brings.
  • New York Attorney General Letitia James has filed suit against crypto exchange KuCoin, alleging that its offering of tokens (including Ether) constitutes the sale of unregistered securities. Notably, this marks the first time that any regulator has alleged that Ether – one of the most widely traded tokens – is a security.
  • Stock trading platform Robinhood announced that it is facing an inquiry from the SEC relating to its “cryptocurrency listings, custody of cryptocurrencies, and platform operations.” The disclosure, which the company included in a February 2023 10-K filing, also states that Robinhood received a subpoena from the California Attorney General seeking information about its trading platform, custody of customer assets, and other topics.
  • The Federal Trade Commission announced that it is pursuing an investigation into “deceptive and unfair marketing” of cryptocurrencies by bankrupt crypto lender Voyager Digital. The agency made this disclosure in its opposition to a proposed plan that would release the defunct company from claims of wrongdoing.
  • The SEC filed suit against Terraform Labs and its founder Do Kwon, accusing him of perpetuating a “fraudulent scheme” that resulted in the loss of $40 billion in value. The essence of the SEC’s complaint is that Kwon misled investors about the stability of the company’s TerraUSD stablecoin, and failed to disclose that its deviation below one dollar would cause the collapse of the company’s Luna cryptocurrency. On March 23, Kwon was arrested in Montenegro and both the U.S. and South Korea are seeking extradition.
  • In mid-February the SEC issued a Wells notice to crypto exchange operator Paxos, notifying it of a possible enforcement action related to its issuance of the Binance USD (“BUSD”) stablecoin. The notice states that BUSD, which Paxos released in partnership with Binance in 2019, is an unregistered security. For its part, Binance maintains that it merely licensed its brand to Paxos, who owns and issues the token. As of Feb. 12, BUSD was the world’s third largest stablecoin by market cap. Its market cap as of early March is estimated at approximately $8.41 billion.
  • In February crypto exchange Kraken reached a settlement with the SEC under which it has agreed to pay $30 million in civil fines and end its staking service for US customers. The SEC accused Kraken of failing to register its service as required by US securities laws; and SEC Enforcement Division Director Gurbir Grewal stated that “Kraken not only offered investors outsized returns untethered to any economic realities, but also retained the right to pay them no returns at all.”

Civil Litigation

  • Sports betting leader DraftKings is facing a class action suit alleging its marketing of NFTs constituted the sale of unregistered securities. The lead plaintiff has also accused the company of misleading users about the fees and commissions it would charge on its proprietary marketplace and the extent to which the tokens’ value depended on DraftKing’s efforts to create and maintain a market for them.
  • FTX debtor company Alameda Research has filed suit against Grayscale Investments in Delaware Chancery Court, alleging that Grayscale’s actions have caused over $250 million of harm to the value of the FTX estate, and $9 billion of harm to Grayscale trust investors more broadly. Alameda asserts that Grayscale’s fee overcharges and lack of a redemption program violate the Trust agreements for its Bitcoin and Ethereum trusts and breach fiduciary duties to trust shareholders.
  • Bolt founder Ryan Breslow has sued a software engineer he hired in 2021 to build his social-impact-focused Movement DAO, claiming that the engineer stole two-thirds of the project’s approximately $16 million in funding. Breslow and his partners allege that the engineer effectively hijacked the DAO and gained control of its funds by fraudulent means. In 2010, the engineer was convicted on wire fraud and money laundering charges for embezzling funds while CEO of a company – a fact of which the plaintiffs allege they were unaware when they hired him.
  • A large group of defendants, including investment firms Sequoia Capital, Paradigm, and Thoma Bravo, and tech-sector law firm Fenwick & West, were accused in a class-action lawsuit of conspiring with FTX and indicted founder Sam Bankman-Fried to perpetuate fraud on the investing public. The lawsuit alleges that the defendants – sophisticated investors, lawyers, and accountants – were aware of FTX’s misuse of customer deposits and commingling of funds with other entities controlled by Bankman-Fried, chiefly Alameda Research.

Bankruptcy Litigation

  • U.S.-based FTX debtors have sued the liquidators of the entity FTX Digital Markets, seeking a declaratory judgment from the U.S. bankruptcy court overseeing their Chapter 11 case in the District of Delaware to end a jurisdictional dispute over the bankruptcy. The U.S. entities argue that Digital Markets has no ownership interest in any FTX assets and was actually “a front to facilitate a conspiracy” to defraud FTX customers.
  • A U.S. bankruptcy judge in New York approved a plan by Binance’s U.S. arm to buy over $1 billion in assets from Voyager Digital, the cryptocurrency lender that filed for bankruptcy in July of 2022. Judge Michael Wiles approved the deal over the objection of the SEC’s, which argued that the transaction might violate securities laws. According to court filings, 97% of 61,300 Voyager account holders favor the proposal, and Voyager’s restructuring advisers claim that selling distressed assets to Binance will allow customers to receive $100 million more than they would otherwise.
  • The U.S. Trustee will appeal a ruling by in FTX’s Chapter 11 case denying the appointment of an independent examiner to investigate the causes of FTX’s collapse. The government argues that an independent examiner is necessary given the scale of loss involved. But bankruptcy Judge John Dorsey sided with FTX management, finding that an examiner would add significant cost and delay to FTX’s bankruptcy process.

Criminal Litigation

  • A federal grand jury in Oregon indicted four Russian nationals, founders of crypto platform Forsage, for allegedly operating a “global Ponzi and pyramid scheme.” Prosecutors accuse the four of bilking investors out of $340 million through fraudulent smart contracts that “automatically diverted” funds from investors. The indictment states that over 80% of Forsage investors received fewer ETH in returns than they invested; and over 50% never received a single payout.
  • On Feb. 23 and Mar. 28, SDNY prosecutors filed superseding indictments against FTX founder Sam Bankman-Fried, adding new charges relating to foreign bribery, illegal political donations, and commodities fraud. Bankman-Fried already faced other criminal charges including wire fraud, securities fraud, and conspiracy to commit money laundering. A federal judge in Manhattan meanwhile stayed the SEC’s and the CFTC’s civil suits against Bankman-Fried pending the resolution of the DOJ’s criminal case against him.
  • A former Coinbase employee has pled guilty in a first-of-its-kind cryptocurrency insider trading case. Ishan Wahi, a former Coinbase product manager, was accused of tipping off third parties, including his brother, about Coinbase’s upcoming token listings, allowing them to exploit increases in the value of tokens when they became available to buy and sell on the Coinbase platform.
    Regulatory and Policy Developments
  • The Public Company Accounting Oversight Board (PCAOB) issued a statement discouraging reliance on “proof of reserve” reports typically issued by crypto companies. The PCAOB stated that such reports provide a picture of a company’s financial health “at a particular moment in time” and are not comprehensive – and thus customers should use “extreme caution” when relying on them.
  • President Biden’s proposed budget plan seeks to apply wash sale rules to cryptocurrencies and related digital assets, which would prevent investors from selling tokens at a loss for tax purposes only to repurchase them. If implemented, crypto would be treated similarly to other traditional securities, thus closing what some commentators call an unfair crypto “loophole.”
    In testimony before the Senate Agriculture Committee, CFTC Chair Rostin Behnam stated that, in his view, stablecoins are commodities. The CFTC was the first federal agency to bring an enforcement action against a stablecoin issuer, fining Tether $41 million in 2021.

Crypto Banking Sector

  • California-based Silvergate Bank, a prominent provider of banking services to crypto companies, decided to voluntarily liquidate its assets and cease operations. Silvergate’s failure was largely a result of a collapse in investor confidence following the bankruptcy of FTX and Alameda Research.
  • Days later, Silicon Valley Bank, long recognized as the most important bank to the startup sector, collapsed after fears of insufficient liquidity triggered a run on deposits. The FDIC and California regulators seized the bank and then guaranteed deposits. On Mar. 27, the government brokered a sale to First Citizens.
  • Signature Bank, a midsize bank with ties to the crypto industry, was shut down by the FDIC and New York regulators after the Silicon Valley Bank collapse led to a run on deposits and a sharp fall in its share price. On Mar. 19, Flagstar Bank agreed to purchase most assets.

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