Blockchain Legal Resource

While ICO issuers have understandably been focused recently on the latest pronouncements from the Securities and Exchange Commission (“SEC”) and other regulators, a second group of potential litigants has largely avoided notice. Seeing a potential bonanza, private plaintiffs law firms have become aggressive in soliciting disgruntled investors as clients and filing lawsuits against issuers of digital tokens.

Historically, early stage and venture-capital-backed companies have not been the subject of much private securities litigation. A number of factors contribute to the historic situation, but before the Initial Coin Offering (“ICO”) phenomenon, the investor base for the typical start-up had preexisting relationships with the founders, and venture capital firms resorted to litigation only as a very last resort. Further, the balance sheet for the typical development stage company did not present an attractive target for litigation.

The ICO phenomenon has changed all that. With tens or even hundreds of millions of dollars raised in individual offerings, plaintiff law firms assume that there is sufficient cash available to pay damages and, more importantly, to fund their own legal fees. Further, in an offering made to all-comers without careful scrutiny of the investor base, the close relationships that in the past have often mitigated against litigation are absent.

What claims do plaintiffs pursue against ICO companies? The federal securities laws allow for a private right of action, so in addition to asserting the unregistered offering of a security, antifraud claims are also typically asserted. Plaintiff firms will make their own Howey argument and are not bound by the SEC’s reasoning in the DAO Report, though when convenient, we have seen plaintiff firms cite it approvingly. Private plaintiffs may also assert traditional breach of contract, tort and common law fraud claims against token issuers.

In addition to traditional tort or contractual damages, another private remedy for an unregistered securities offering is rescission—the return of funds to investors. Many states require that the issuer pay interest on invested funds, so it is theoretically possible that an issuer in an unlawful securities offering would be required to return more than 100 percent of investor monies.

Private lawsuits proceed in parallel to any SEC or other governmental investigation. These factors should cause the prudent ICO issuer to seek the advice of experienced counsel before engaging in any offering of a token or other digital asset.