Crypto investors’ class action settlement with Block.one killed by NY judge

(Reuters) – Securities class-action settlements by cryptocurrency investors are extremely rare. Issuers of crypto tokens largely designed their offerings to avoid the reach of US securities laws, at least as they are used by retail investors.

That was smart: I’ve written more than once in the past couple of years about federal judges throwing out securities because crypto investors couldn’t show their trades were protected by US law.

Block.one was one of the few crypto defendants who decided to settle with investors. In June 2021 – before any decision on its motion to dismiss a fraud class action by token holders – the Cayman Islands-based blockchain company agreed to a proposed settlement of $27.5 million. The deal was meant to resolve investor allegations that Block.one sold unregistered securities in a 2017 offering to raise capital to develop its platform, and that the company later misled token holders about how the blockchain worked.

As far as I know, Block.one’s settlement would be the largest class action recovery ever for crypto investors, just ahead of a $25 million settlement with the Tezos Foundation.

But that’s not going to happen. On Monday, U.S. District Judge Lewis Kaplan of Manhattan refused to grant final approval of the proposed $27.5 million settlement. The judge concluded that the investor class is inherently conflicted because some tokenholder purchases are covered by US law, while others are not. Kaplan said the lead plaintiff in the class action, Crypto Assets Opportunity Fund LLC, could not adequately represent the interests of investors whose transactions took place in the United States because the fund also engaged in foreign Block.one token transactions.

In other words, crypto investors cannot get past the viability hurdles of the US Supreme Court’s 2010 ruling in Morrison v. National Australia Bank Ltd, even when the defendants want to settle. (More on Morrison in a minute.) That must be a sobering thought for plaintiffs’ lawyers trying to recoup token holders’ losses from this year’s crypto downturn.

Grant & Eisenhofer, which represents the lead plaintiff in the Block.one class action, did not respond to my question about Kaplan’s ruling. The firm had asked for $5.5 million in fees, which the judge rejected, though he emphasized that his decision to reject the settlement was based on structural problems with the deal, not Grant & Eisenhofer’s conduct in the case.

Block.one and its counsel, Edmund Polubinski of Davis Polk & Wardwell, also did not respond to my emails. Block.one previously reached a $24 million settlement with the US Securities and Exchange Commission in 2019 to resolve SEC claims about the sale of unregistered securities. The company denied the fraud allegations asserted in the investor class action.

In Morrison, as you know, the Supreme Court limited the extraterritorial reach of US securities laws, holding that the laws apply only to securities listed on US-based exchanges and to “domestic transactions” in other securities. For investors suing crypto defendants based outside the US, it has been a challenge to show that their trades are domestic.

Block.one, like just about every other non-US crypto defendant, insisted in its motion to dismiss that none of the lead plaintiff’s transactions took place on a US exchange or in a domestic transaction, as that phrase has been interpreted by the 2nd US Circuit Court of Appeals.

Grant & Eisenhofer argued in their statement of opposition that Block.one’s initial coin offering was processed through its servers in California, making token purchase domestic transactions. And many subsequent trades involving Block.one-related tokens, according to the lead plaintiff’s brief, were either executed on US-based crypto exchanges or were verified by blockchain producers clustered in the US

Grant & Eisenhofer cited the Tezos class action lawsuit, in which US District Judge Richard Seeborg of San Francisco concluded in 2018 that the defendants’ US-based server, combined with the concentration of Tezos blockchain users in the US, was sufficient to trigger US securities laws.

As I mentioned, the judge in the Block.one case did not rule on the merits of the company’s termination petition. Instead, Kaplan dismissed the proposal without prejudice after the two sides reached a proposed settlement in June 2021, noting that Block.one could revive the proposal if he rejected the deal. However, Kaplan remained concerned about questions about Morrison’s extraterritoriality. Two weeks before the settlement’s final approval hearing last November, the judge asked Grant & Eisenhofer to address whether the Crypto Assets Opportunity Fund’s transactions were foreign or domestic and what impact that might have on the fund’s ability to represent absent class members.

During the Nov. 17 hearing, Daniel Berger of Grant & Eisenhofer sought to assure Kaplan that at least 25% of the fund’s trades in Block.one-related tokens were domestic transactions. Kaplan even said the percentage casts doubt on the fund’s representation of absent class members whose trading was entirely domestic. The judge also said the settlement’s plan for allocating relief to investors did not account for differences in the strength of their claims based on Morrison considerations.

In a follow-up letter, Grant & Eisenhofer said that nearly half of the fund’s trades in Block.one tokens took place on what the SEC would define as a US crypto exchange. With such a large proportion of its own trades immune to Morrison defences, the fund said, its interests were aligned with absentee investors whose trades were also domestic.

That wasn’t good enough for Kaplan. The judge said the fund had not provided him with sufficient evidence to address his concern that it “may have, to some extent, ‘traded away’ viable claims of absent class members” in favor of a deal that offered investors compensation even for foreign transactions.

Kaplan said it should be possible, based on blockchain technology, to determine on a trade basis whether transactions were conducted in the United States or overseas — and thus whether or not class members have viable U.S. claims. The judge did not suggest the next steps in the class action, and as I mentioned, neither side told me their plans.

Block.one attorney Polubinski told Kaplan during the fairness hearing that his client wants a global solution. Perhaps the answer would be a revised allocation plan that favors investors who can prove their trades took place in the United States

Read more:

New Binance class action likely clears one hurdle, but faces many others

SEC fines blockchain company Block.one $24 million over coin offerings