Blockchain Litigation, 2018: Murphy & McGonigle Reports

Thom Thompson

Thom Thompson

Contributing Editor

Earlier this month Murphy & McGonigle (M&M), an East Coast law firm with a prominent securities and financial services practice, released its Blockchain Litigation: 2018 Year in Review Report.  According to the firm, the report is based on data from its Blockchain Litigation Database, which the firm’s FinTech and Blockchain Practice launched to track litigation trends in the United States. The report is available for download here.

Even casual observers of the blockchain industry were likely struck by the notable increase in legal actions involving the industry last year. Until 2016, the annual number of blockchain cases filed in the United States was a dozen or fewer. As the report notes, as the number of cryptocurrency wallets in use took off in 2017 and ’18, so did blockchain litigation.

According to Daniel Payne, an attorney and shareholder in M&M’s FinTech and blockchain Practice,  “The focus of litigation has been on cryptocurrencies rather than other blockchain use cases because, as they say, that’s where the money is.  ICOs in the last couple of years raised hundreds of millions of dollars from the public, while blockchain companies focused on other use cases are privately growing more deliberately.  The main non-cryptocurrency legal issue we have seen so far is enforcement of smart contracts. And we are monitoring further developments in blockchain litigation outside of cryptocurrencies.”

One of the details that jumps out in the report is that among state authorities, Texas brought the most cases among the states filing the 46 administrative actions last year. California and New York brought none. New York’s BitLicense, I assume, has effectively signaled the state’s attitude toward blockchain , but California’s lack of activity is interesting. By the way, Illinois also brought none.

All of the state cases involved allegations of violations of state “blue sky” laws, which are state securities laws. In one example of a state action, South Carolina ordered Genesis Mining to cease doing business in the state after officials there became aware of complaints from local customers about the company’s Iceland-based cloud mining service. In cloud mining, customers pay a mining subscription fee which supports their pooled shares in bitcoin mining and against which they receive payouts proportional to their payments. Complaints had focused on bad service and customers’ concerns about fraud. The SC attorney general, who is also the securities commissioner, asserted that the mining contracts were securities under the state blue sky law.

On the federal level, 47 cases included at least one allegation of a breach of federal securities laws. Against a backdrop of a rapidly diminishing number of initial coin offerings, the SEC moved against several coin issuers in 2018. The Securities and Exchange Commission started taking a decidedly tough stance toward fraudulent actors and moved aggressively toward a number of them. Many of the cases ended with consent orders that enjoined the defendants from continuing in the business, required payment of a fine and called for disgorgement of profits.

But not always. The SEC’s efforts were set back when a federal court denied the SEC a preliminary injunction in a case it had brought against a company called Blockvest. The court ordered a hearing on the nature of Blockvest’s business to determine whether it had in fact violated securities laws. While the decision left the SEC red-faced, the court held that the questions yet to be decided were regarding facts and representations by Blockvest and not a challenge to the SEC’s jurisdiction. (The SEC did get the last laugh earlier this month when Blockvest’s attorney petitioned to withdraw from the case due to the attorney’s own concerns about the client. The court released the attorney and granted the SEC’s request for an injunction.)

In autumn 2018, the SEC showed its kinder, gentler side when it permitted two ICO issuers (Airfox and Paragon) to pay fines, repay investors, issue compliant securities and work their way into compliance. There were no allegations of fraud connected with their improper ICOs. Airfox is designed to facilitate low value financial services for the unbanked. Paragon is a blockchain technology company focused on serving the legal cannabis industry. So the SEC was also showing its decidedly hipper side with these settlements.

The report from McGonigle and Murphy also highlights the inchoate struggle to understand legal jurisdiction when it comes to blockchain, especially the public ones. Blockchains like bitcoin have a decentralized organization which is nowhere and operations based on computer servers (nodes) which are everywhere. Only a few cases have come to the U.S. courts so far, but it feels like the questions about jurisdiction will provide plenty of matters for litigation in the future. As M&M’s Payne notes, “Jurisdiction issues are a great example of the importance of tracking blockchain litigation to stay abreast of the legal regime applicable to the blockchain industry.”  

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