Judge Paul A. Crotty of the Southern District of New York has dismissed a putative securities fraud class action brought against Xunlei Limited, a Chinese provider of blockchain-based storage and compute power. Xunlei offered rewards in the form of cryptocurrency called "OneCoin" to miners who made idle computing power available to the blockchain. Plaintiffs, who were holders of Xunlei American Depository Shares listed on NASDAQ, alleged in their complaint that Xunlei violated Rule 10(b) of the Securities Exchange Act by making material misrepresentation and omissions concerning its compliance with a Chinese law precluding "fundraising through coin offerings."

In September 2017, Xunlei launched a device called "OneThing Cloud," a "network linked storage device that utilizes blockchain technology to enable multiple users to share online storage remotely, instead of from a centralized server," according to the complaint. One month later, Xunlei introduced its "OneCoin Rewards Program, which permitted users of OneThing Cloud to leverage excess storage and computing power to mine OneCoin. Holders of OneCoin could trade them via chat groups or on certain third-party exchanges. OneCoin's wallet functionality permitted these transactions, but Xunlei never encouraged such transactions nor did it make affirmative efforts to have OneCoin listed on the exchanges.

The same month that Xunlei launched OneThing Cloud (September 2017), several Chinese regulatory bodies jointly issued a notice concerning "fundraising through coin offering." The notice described the risks associated with "fundraising activities through issuing tokens including Initial Coin Offering (ICO)" and immediately banned "fundraising through coin offering." It also precluded tokens that provide "trading and exchange services for coin offering from engaging in exchange businesses between legal tender and token or 'virtual currency.'" In its October 2017 press release announcing the OneCoin Rewards Program, Xunwei did not address the regulatory notice. In November 2017, on a call to discuss third quarter financial results, Xunlei CEO Lei Chen stated that, "from the beginning" Xunlei had "no plan to monetize on this coin, and we certainly do not in the future." A later dispute with a business partner resulted in a public accusation that OneCoin was a "disguised ICO" and an "illegal fundraising scam." The price of Xunwei ADS's fell following the accusation.

The gravamen of plaintiffs' complaint was that the OneCoin Rewards Program was illegal and thus banned in China pursuant to the September 2017 regulatory notice, but that defendants failed to disclose that fact to its American investors. Judge Crotty noted that Chinese authorities had taken no action against Xunlei. The Court then analyzed the 2017 regulatory notice and concluded that plaintiffs failed to plausibly allege that Xunlei was in violation of it. Judge Crotty observed that while the regulatory notice undoubtedly banned ICOs in China, it was less clear what transactions constitute an ICO under the notice. Recent Chinese authority examined by the Court provided that whether a transaction was an ICO required a "case-by-case" assessment, as was the case in the United States.

Ultimately, Judge Crotty granted defendants' motion to dismiss, determining that plaintiffs failed to "allege that Xunlei fundraised or raised money in any way through the Rewards Program," nor did they allege that OneThing Cloud was a sham device. Rather, Plaintiffs alleged only that third party speculators created markets for trading in OneCoin, and at most alleged that "Xunlei encouraged this trading by incorporating a sense of urgency into the Rewards Program, . . . and advertising and maintaining the functionality of the Wallet App, which made the extraction of OneCoin to these other platforms possible."

Token issuers should be increasingly concerned that foreign courts may be called to upon to determine the legality of cryptocurrency transactions in the issuer's home jurisdiction. Here, the Court concluded that, at most, plaintiffs allegations "essentially boil down to a theory of 'aiding and abetting' or 'willful blindness," for which liability did not attach under Chinese securities laws. Indeed, Judge Crotty pointedly noted that "[n]othing in the [regulatory notice] or the China Securities Law places an affirmative duty on the issuers of a token to control or prevent subsequent trading of that token on platforms it neither affiliates with nor sponsors." Such laws may differ elsewhere.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.