Crypto litigation risk heats up: promoters & VCs on notice

Update on key litigation trends

Crypto’s recent tumultuous ride has seen class action and general litigation risk increase.  There is a growing wave of class action litigation abroad (particularly in the US) alleging that investors had the risks of crypto investments misrepresented to them or were mis-sold products.  Rather than targeting crypto asset providers or exchanges themselves, some investors are seeking to recoup their losses from parties who promoted certain crypto assets and exchanges.  Alongside the influx of private class actions, regulators are increasing focus on participants within the crypto industry, and demonstrating an appetite for greater oversight over the industry.

Anyone active in the broader crypto ecosystem should be aware of the key litigation and enforcement action unfolding in Australia and overseas.  A snapshot of recent litigation trends, including the more recent trend of lawsuits being brought against promoters, is set out below. 

Overview of recent international litigation trends

The US has seen 22 crypto securities class actions filed in 2022 alone[1] with other actions relating to the classification and regulation of crypto within wider securities regulatory frameworks.  These are emerging areas and developments in the US context may have implications for Australia (see a previous article, ‘Cryptocurrency Class Actions’ from us on this issue in our 2022 Class Actions in Australia Report here). 

Changes in the legal landscape, crypto industry and in crypto’s use cases have, however, seen litigation reaching well beyond securities law.[2]  Crypto assets have increasing been the subject of litigation in regular commercial cases including contractual disputes, bankruptcy and the recovery proceedings and intellectual property disputes.  A recent example can be seen in Coinbase v Bielski, the first cryptocurrency related lawsuit being heard in the US Supreme Court.[3] The case concerns a purely procedural point about whether the proceeding should be heard in arbitration rather than raising substantive crypto issues for determination by the Supreme Court.  It does, however, demonstrate how crypto has become part of the wider litigation landscape in the United States.

Regulators, both in the US and Australia, have also brought enforcement actions in relation to the crypto industry.  A recent example is the Commodity Futures Trading Commission’s (CFTC) action against leading crypto exchange Binance, alleging violations of US derivatives law.[4]  Within days of the CFTC announcing its action against Binance, Australian Securities and Investments Commission (ASIC) also issued a notice of hearing under s915C of the Corporation Act to consider whether to suspend Binance’s financial services licence for derivatives which Binance relinquished about a week later.[5]

Issue in focus: promoter liability

Recent class actions and regulatory enforcement actions in this space have expanded to include parties who promoted crypto products and exchanges, such as high-profile public figures (or ‘influencers’) and private equity (PE) and venture capital (VC) funds backing key assets and exchanges.

Public figures / influencers

In the US, the first class action commenced in the wake of the FTX collapse was Garrison v. Bankman-Fried et al (Garrison), filed in November 2022.  Garrison seeks to recoup plaintiff investors’ losses from FTX’s founder Sam Bankman-Fried and, significantly, from a number of high-profile public figures (including NFL player Tom Brady and comedian Larry David) who promoted FTX.  The class action alleges that the defendants promoted, assisted in, and/or actively participated in the offer and sale of unregistered securities, being the yield-bearing accounts (YBAs) FTX was offering.  This action specifically targets public figures who are alleged to have promoted unregistered securities or failed to properly disclose their payments and compensation.  The essence of the allegation is that FTX’s YBAs are securities, and that anyone, including celebrities and influencers, who aided in the sale of that security, may be liable for any damage caused.  Class actions have also been brought in Florida and California against FTX and the high-profile figures who promoted it.

Regulators, both in the US and Australia, are also focusing on persons who promoted crypto assets and exchanges and whether, for example, they engaged in misleading and deceptive conduct or provided financial services without a licence. 

In the US, the Securities and Exchange Commission (SEC) has brought several enforcement actions, including a well-publicised action against reality TV star Kim Kardashian for her promotion of a product offered by EthereumMax allegedly without disclosing the financial benefits received in exchange.[6]  In Australia, the ASIC has pursued ‘finfluencers’ who provide financial services without a licence, for example by making share purchase recommendations on social media, though to date these cases have not extended to crypto products and exchanges.  In one enforcement action brought by ASIC, the Federal Court of Australia found that a ‘finfluencer’, with the social media handle, @ASXWOLF_TS’, contravened s 911A of the Corporations Act 2001 (Cth) (Corporations Act) by delivering training courses about trading in ASX-listed securities, promoting these courses through social media, and posting purchase recommendations to Instagram.[7]

VC and PE funds

In recouping their losses, some investors are also turning their attention to the PE and VC funds who backed the crypto assets and exchanges.  One class action brought by investors in FTX in California, Rabbitte v Sequoia Capital,[8] names PE and VC funds (including Sequoia Capital, Thoma Bravo and Paradigm) as defendants, alleging that they gave the exchange an ‘air of legitimacy’ and that:

As a result of [their] significant investments in the FTX entities, each was incentivized to leverage their professional reputations and media outreach capabilities to portray FTX as a trustworthy and legitimate crypto exchange

The actions listed in the complaint include a public event where a Sequoia partner interviewed Bankman-Fried titled ‘The Unstoppable Rise of FTX’ and a flattering 14,000 word piece about Bankman-Fried and FTX that Sequoia had published on its website.  The complaint also points to the VC funds’ claims that they conducted extensive due diligence into FTX and, on that basis, vouched for the exchange’s strength.

Conclusion

As crypto assets have gained greater use and acceptance, they have made appearances in an increasingly broad range of disputes.  While the status of crypto assets remains a key issue in the class actions and regulatory enforcement actions being brought in the industry, it appears that the means by which private plaintiffs are seeking to recoup their losses, and regulators are exercising their oversight, is expanding.  All participants in the crypto ecosystem should be aware of how their role – whether in the promotion, investment, or creation of crypto assets - can attract class action or other litigation risk.