On September 6, 2024, Judge Robert Pitman of the United States District Court for the Western District of Texas dismissed a putative securities class action against a family of corporations ("Corporate Defendants") that, together, control and operate a decentralized cryptocurrency exchange and blockchain protocol (the "Protocol"), and its individual founders (the "Individual Defendants" and together "Defendants"), asserting claims under Sections 5 and 12(a)(1) of the Securities Act of 1933 ("Securities Act"), Sections 5, 10(b), 15(a)(1) and 29(b) of the Exchange Act of 1934 ("Exchange Act"), and Rule 10b-5. Plaintiffs alleged that defendants touted complete protection from losses to investments in the Protocol in order to attract investors, which ultimately proved illusory when a surge of withdrawals from the Protocol's exchange strained its liquidity and caused investors to suffer significant losses. S. Magistrate Judge Mark Lane found in a Report & Recommendation, dated July 31, 2024 ("R&R"), that the Court lacked personal jurisdiction over defendants and that the federal securities laws are inapplicable to the transactions at issue, and recommended that the suit be dismissed in its entirety. Reviewing the R&R de novo, Judge Pitman adopted its reasoning and dismissed the suit without prejudice. Basic et. al. v. BProtocol Foundation et. al., A-23-CV-533-RP, (W.D. Tex. Sept. 6, 2024).
The Protocol allegedly is an automated online platform, or an exchange, which enables users to invest and trade cryptocurrency assets. It is owned, developed, and maintained by the Corporate Defendants, who are comprised of: a private corporation that developed the Protocol, located in and founded under the laws of Israel; a non-profit organization that promotes the development and adoption of the Protocol, located in and founded under the laws of Switzerland; and an unincorporated general partnership that runs the Protocol, which has no physical office, location, mailing address, directors, or agents, and is not registered in any jurisdiction. The Individual Defendants are all Israeli citizens residing in Israel.
In order to maintain sufficient liquidity so that it could facilitate cryptocurrency trades and compete with other exchanges, the Protocol offered a series of investment products. In exchange for their investments, the Protocol would pay investors a portion of the fees charged on crypto-asset trades made on the platform. To further entice investment, the Protocol allegedly advertised the products' "impertinent loss protection feature," which allegedly shielded investors from certain losses endemic to cryptocurrency exchanges. When, in June 2022, the crypto market experienced waves of defaults and volatility, there allegedly was a spike of withdrawals from the Protocol's exchange. The Protocol then allegedly became responsible for covering all investor losses under the impertinent loss protection—it failed to do so, and investors allegedly lost millions of dollars. Plaintiffs, Americans who invested in the Protocol, brought suit under various provisions of the Securities Act and the Exchange Act. Defendants moved to dismiss the action for, inter alia, lack of personal jurisdiction and inapplicability of the federal securities laws to the transactions at issue. The Court agreed.
The Court first addressed personal jurisdiction, considering whether plaintiffs had adequately alleged that both Individual and Corporate Defendants had minimum contacts with the United States and that those contacts gave rise, or directly related, to plaintiffs' claims. The Court found that Plaintiffs did not identify any contacts between any Individual Defendants and the United States, but rather attempted to impute Corporate Defendants' contacts to Individual Defendants. The Court held that plaintiffs could not do so without providing additional allegations that would enable the Court to disregard the Corporate Defendants' corporate formalities and, thus, held that plaintiffs failed to allege personal jurisdiction over Individual Plaintiffs.
As to the Corporate Defendants, plaintiffs alleged their contacts with the United States derived from attending and sponsoring industry events at which the Protocol advertised investment products, marketing and promoting its presence on social media, and maintaining a website. The Court concluded that these facts were insufficient to form the basis of specific personal jurisdiction. In so holding, the Court found it to be significant that plaintiffs did not allege their claims related in any way to defendants' attendance and sponsorships at industry events in the United States. Furthermore, the Court held that neither social media posts nor a website provided an adequate jurisdictional hook, because plaintiffs failed to provide any facts from which to infer such activity was specifically targeted to the United States, as opposed to the rest of the world.
The Court next turned to whether plaintiffs had adequately identified "domestic transactions," as defined by the Supreme Court in Morrison v. National Australia Bank Ltd., 561 U.S. 247, 267 (2010). The Court found guidance from the Second Circuit's recent decision in Williams v. Binance, 96 F.4th 129 (2nd Cir. 2024), which also involved the purchase of crypt-asset tokens by Americans on an international exchange. There, plaintiffs plausibly alleged domestic transactions by pleading that: (1) they transacted with the exchange from the United States; (2) the transactions at issue occurred in part on the platform's infrastructure located in the United States; (3) their buy orders became irrevocable once processed on that infrastructure; and (4) comity concerns were minimal given the exchange's unregistered status and absence of physical location. We previously covered the Binance decision, here.
Applying Binance, the Court found that plaintiffs' allegations were insufficient to establish a domestic transaction. First, the Court found plaintiffs failed to allege any facts showing irrevocable liability or that titled passed within the United States once plaintiffs completed a buy order. Moreover, the Court concluded that, unlike in Binance, where defendants had effectively run away from the authority of all jurisdictions, nearly all defendants' physical presence in Israel and Switzerland and, thus, comity concerns were heightened. The Court opined that plaintiffs could pursue their grievances against defendants in those forums. Accordingly, the Court dismissed the action without prejudice.
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