On August 29, 2023, Judge Katherine Polk Failla of the United
States District Court for the Southern District of New York
dismissed with prejudice a putative class action against a
decentralized cryptocurrency trading platform and certain of its
investors under Section 12(a)(1) of the Securities Act and Section
29(b) of the Securities Exchange Act. Risley v. Universal
Navigation Inc., 2023 WL 5609200 (S.D.N.Y. Aug. 29, 2023).
Plaintiffs alleged that they purchased fraudulent cryptocurrency
tokens on the exchange. The Court held, assuming but not deciding
that the tokens were securities, that plaintiffs failed to state a
claim for rescission.
The Court explained that the cryptocurrency platform's
structure, which facilitates trades with the use of various
self-executing "smart" contracts and pairs traders in a
liquidity pool, prevented plaintiffs from identifying who issued
the tokens that they purchased. Id. at *3–9. As the
Court observed, "therein lies plaintiffs' dilemma,"
since plaintiffs were unable to seek redress from the issuers of
the tokens themselves and instead were relegated to arguing that
defendants should be liable for having facilitated the trades at
issue, and that defendants "sold" plaintiffs the tokens
by virtue of having established the smart contract structure
through which plaintiffs obtained their tokens. Id. at
*11. Plaintiffs also sought to hold defendants liable for making
statements that the platform was "for many people,"
"safe" to trade on, and for "transferring
title" of the tokens in each liquidity pool to plaintiffs in
violation of the Securities Act. Id.
The Court first explained that plaintiffs' Section 29(b) claims
failed because defendants merely created computer code to support
the execution of smart contracts that governed transactions on the
platform. Id. at *12. The Court distinguished those
contracts from the contracts governing the tokens
themselves—the smart contracts defendants created wrote code
that allow the platform to operate, while the token contracts were
drafted by the token issuers themselves and provided the terms of
the sale of the token and the rights that transaction afforded.
Id. at *13–14. The Court observed that defendants
were not responsible for the token contracts but were merely
responsible for designing protocols pursuant to which those
contracts could be executed. Id. at *13. And the Court
held that, even if defendants' smart contracts were the
applicable contracts governing the transactions and even if they
could be rescinded, rescission would still not be warranted because
the contracts were not unlawful on their face. Instead, the Court
agreed with a decision issued by Judge Engelmayer (the subject of
our prior post) and analogized that the smart contracts
operated as a type of user agreement that was not a
transaction-specific contract, but rather a series of protocols
designed to provide for uniform transactions. Id. Because
these smart contracts were able to be carried out lawfully to
facilitate the exchange of cryptocurrencies, they were thus
collateral to the fraudulent issuance of the tokens that plaintiffs
purchased. Id. at *14.
The Court rejected plaintiffs' analogy that failing to hold
defendants liable would be like failing to hold liable a technology
company that created self-driving cars that caused injuries
regardless of whether the company was responsible for the flaws in
the car. Id. The Court explained that this analogy failed
because it presumed that defendants had caused plaintiffs harm by
having created a system that could allow for fraud to occur, and
thus was more like trying to hold a payment transfer platform
liable for a drug deal where payment was facilitated by those
means. Id. "There, as here, collateral, third-party
human intervention causes the harm, not the underlying
platform." Id. The Court cautioned that the operation
of such platforms could soon become the province of securities
regulations, which counseled in favor of caution here. Id.
at *15.
The Court next assessed plaintiffs' Section 12(a)(1) claims.
The Court rejected plaintiffs' arguments that defendants were
statutory sellers. Id. The Court specifically rejected the
contention that simply because defendants designed protocols
allowing the platform to operate meant that they passed title to
the tokens to plaintiffs. Id. at *16. The Court noted
adopting this rule would mean that any exchange that facilitated
transactions could be held liable under Section 12(a)(1).
Id. As the Court explained, just as those who "draft
base-level agreements for traders to access the stock market"
are not statutory sellers under the securities laws, neither are
"software coders who create an exchange to efficiently
facilitate trades. In both circumstances, the party sued
facilitated—but was not party to—the contested
transaction." Id. To the extent that plaintiffs
contended that there were moments where title was held by the
software for an instant in the course of transitioning title
automatically from one party to the other, that was not sufficient
to create liability because the buyers did not in any meaningful
sense purchase the security from defendants. Id. at
*17–18. The Court also rejected plaintiffs' suggestion
that defendants sold, promoted, and/or solicited tokens to
plaintiffs in order to increase the value of tokens defendants
created, noting that plaintiffs only offered conclusory allegations
that defendants actually sold, promoted, and/or sold the tokens,
and didn't even allege that such solicitation efforts were
successful. Id. at *18. The Court reasoned by way of
analogy that a stock exchange would not be liable for making
statements that it is a safe place to trade. Id. at *19.
The Court also emphasized that any allegations that defendants
obtained some sort of profit from plaintiffs' transaction fees
that were paid in connection with the fraudulent transactions were
also conclusory. Id.
Risley v. Universal Navigation Inc.
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