On February 1, 2023, Judge Paul A. Engelmayer of the United
States District Court for the Southern District of New York
dismissed a putative class action against a cryptocurrency exchange
company, its parent, and the parent's CEO, asserting claims
under Section 12(a)(1) of the Securities Act of 1933, Section 29(b)
of the Securities Exchange Act of 1934, and certain California,
Florida, and New Jersey statutes. Underwood v. Coinbase Global,
Inc.,—F. Supp. 3d—, 2023 WL 1431965 (S.D.N.Y.
2023). Plaintiffs alleged that the company sold or solicited
securities, and entered into contracts to buy and sell securities,
without registering as an exchange or broker-dealer. The Court held
that, even if cryptocurrencies were deemed securities, plaintiffs
failed to adequately allege that the company itself sold or
solicited cryptocurrency tokens to or from exchange participants,
or that any contract with the company required plaintiffs to
purchase or sell prohibited securities.
With respect to plaintiffs' Securities Act allegations, the
Court analyzed whether the company qualified as a "statutory
seller" by either (1) directly selling a security to
plaintiffs (requiring that the company "passed title" in
cryptocurrency tokens to plaintiffs as the "immediate
seller"), or (2) actively soliciting the sale of a security to
plaintiffs for its financial gain. Id. at *5-6 (citing
Pinter v. Dahl, 486 U.S. 622, 642, 647 (1988)). The Court
assumed, for purposes of its analysis, that the cryptocurrencies
were "securities," but still held plaintiffs'
allegations deficient.
To argue that the company was a direct seller, plaintiffs pointed
to allegations in their amended complaint that the company held its
customers' cryptocurrency tokens in a centralized virtual
"wallet," that the customers were "not in
privity" with each other, and that the customers
"transact[ed] solely with [the company] itself."
Coinbase, 2023 WL 1431965, at *6. The Court noted that,
although such allegations "would ordinarily assist plaintiffs
in pleading" that a defendant was a statutory seller, the
amended complaint was contradicted by other allegations in
plaintiffs' original complaint. For example, the Court observed
that the original complaint had alleged that the company's
customers could choose to "enter into trade agreements with
other [exchange] users for purchases and sales of digital
assets." Id. at *7. Moreover, the Court emphasized
that the company's User Agreement—which the original
complaint referenced and plaintiffs themselves filed with the Court
as part of a separate motion seeking to avoid
arbitration—expressly provided that title to customers'
cryptocurrency tokens "shall at all times remain with [the
user] and shall not transfer to [the exchange]" and that
customers "are not buying [cryptocurrency] from [the exchange]
or selling [cryptocurrency] to [the exchange]" but rather that
the company "acts as the agent, transacting on your behalf, to
facilitate that purchase or sale between you and other [exchange]
customers." Id. at *8. The Court therefore concluded
that it "need not, and does not, accept the [amended
complaint's] contrary allegations, which unavoidably emerge as
strategically added to elude the facts pled in the [original]
Complaint and contained in the User Agreement that checkmate
plaintiffs from adequately pleading the first prong of
Pinter's statutory seller inquiry."
Id.
The Court further concluded that plaintiffs failed to adequately
allege that the company "solicited" plaintiffs'
purchases. The Court explained that although a defendant could be
deemed a statutory seller based on "direct and active
participation in the solicitation of the immediate sale,"
plaintiffs' allegations—that the company provided users
with descriptions of different cryptocurrency tokens, provided
certain free tokens as promotions, and wrote certain news updates
and provided website links to others—were too
"collateral" to amount to solicitation under the
Securities Act. Id. at *9. Moreover, the Court observed
that actionable solicitation would also require plaintiffs to have
purchased or sold a security as a direct result of defendant's
alleged solicitations, which plaintiffs failed to allege.
Id.
In addition, the Court held that plaintiffs failed to adequately
allege a claim under Section 29(b) of the Exchange Act, which
provides for the voiding of contracts that, if performed, would
violate other provisions of the Exchange Act. While the parties
disputed whether a private right of action was available, the Court
rejected for lack of factual support plaintiffs' theory that
purchases and sales on the exchange "constitute individual
contracts that are voidable." Id. at *11. Rather, the
Court further observed that, "[a]s pled, the only contract
capable of rescission here under Section 29(b) is the User
Agreement," because the original complaint had alleged that
plaintiffs purchased securities "pursuant to" the User
Agreement. Id. at *12. The Court concluded that the User
Agreement was not voidable because even if, as plaintiffs alleged,
certain transactions in certain assets were prohibited, the User
Agreement did not require any user to engage in such transactions.
Id.
Having dismissed the claims for primary violations of the
Securities Act and Exchange Act, the Court likewise dismissed
plaintiffs' claims for control person liability. Id.
Moreover, the Court concluded that leave to amend would be futile,
because plaintiffs had already amended their complaint, used that
opportunity to add allegations that "directly contradicted
their initial Complaint," and failed to show how the
deficiencies identified by the Court could be cured. Id.
at *13. With respect to plaintiffs' state-law claims, however,
the Court declined to exercise supplemental jurisdiction and noted
that dismissal of those claims was therefore without prejudice.
Id.
Underwood v. Coinbase Global, Inc.
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