Recent Landmark Decision in Cryptocurrency Law

A recent decision in the United States District Court for the Southern District of New York has sent shockwaves through the world of cryptocurrency investing.  In re Bibox Group Holdings Ltd. Securities Litigation, the Court ruled that a plaintiff did not have standing to assert class claims on cryptocurrency assets he did not own.  However, it was what the court didn’t rule on that made this a landmark case in the legal field developing around cryptocurrency, as the Court took no issue with the fact that the Plaintiff brought a case alleging securities violations against a cryptocurrency issuer and exchange.

The background on this matter is as follows.  In October 2017, Bibox Group Holdings Ltd. and their affiliates funded the launch of their new crypto exchange by launching a new ERC-20 cryptocurrency called BIX.  In this offering of BIX, Bibox raised approximately $19 million in funding.  Bibox told investors that they could exchange BIX for tokens on their exchange, and Bibox would use a portion of the funds raised in the offering to buy back some of the BIX that was issued.  BIX was one of six ERC-20 tokens on the exchange, with the others being EOS, TRX, OMG, LEND, and ELF.

The Plaintiff, Mr. Alexander Clifford, was one of the initial investors who bought BIX.  Mr. Clifford ended up exchanging his BIX for Bitcoin in December 2018.  Mr. Clifford never purchased or owned any of the other tokens.  On April 3, 2020, Mr. Clifford then filed an action in the Southern District of New York against Bibox and their affiliates.  In his complaint, Mr. Clifford alleged that Bibox had violated federal securities law and state Blue Sky law in connection with the trading activities of the six tokens.  Defendants moved for a motion to dismiss, arguing that Mr. Clifford lacked standing since he was asserting claims based on the five tokens he did not purchase, and that his claims pertaining to the one token he owned were time-barred.

Judge Denise Cote of the Southern District of New York granted the motion to dismiss as to all claims, ruling that Plaintiff lacked standing to assert claims based on the five tokens he had never purchased.  This was for two reasons.  First, the Plaintiff did not suffer any injury from the unpurchased tokens.  Second, the Court precluded standing on the grounds that “such conduct implicates the same set of concerns as the conduct alleged to have caused injury to other members of the putative class[1]” because all the tokens were made by different entities and had distinct characteristics and advertising history, meaning the injuries could not be proven in a similar enough way to allege standing.

The Court also dismissed the remainder of claims Plaintiff asserted on the token he did purchase, BIX.  In doing so, the Court rejected the argument that the one-year statute of limitations began to run when the cryptocurrency Plaintiff discovered the token could qualify as a security.  This is because the SEC had previously issued a publication on April 3, 2019 stating that cryptocurrencies may be qualified as securities under the Howey test in the right circumstances.  Rather, the Court held that the statute of limitations began to run when Plaintiff became aware of his injury, which was his last transaction in April 2018.

The main takeaway here is that the Court did not rule that securities laws did not apply to crypto, but rather took issue with the Plaintiff’s standing.  It makes it clear that cryptocurrency issuers and exchanges could be held liable under securities law for their actions.  In addition, while the Court precluded the “same set of concerns is implicated” argument, it is possible another court could find otherwise.  This is due to the fact that the six tokens were on the same exchange, used the same blockchain and were based on the same technological standard.  In conclusion, the rapidly developing field of law around cryptocurrency is one that continues to require close monitoring because of major developments such as this.

[1] Ret. Bd. of the Policemen’s Annuity & Ben. Fund of the City of Chicago v. Bank of N.Y. Mellon, 775 F.3d 154, 161 (2d Cir. 2014)

Pastore Retained to Advise a Large Registered Investment Advisor in Sale

Pastore was retained to advise a large registered investment advisor in connection with the sale of its business to Victory Capital Holdings, a large national registered investment advisor.  The registered investment advisor, based in Connecticut, invested primarily in microcap securities, providing services primarily to institutional investors and large religious-affiliated clients. The advisor, which was previously owned by Old Mutual Asset Management Trust Investment Funds LLC, spun out in 2009.

Pastore Retained to Advise Multibillion-dollar Registered Investment Advisor in Restructuring

Pastore was retained to advise a multi-billion-dollar registered investment advisor and related private equity funds on the restructuring of the advisor. Pastore advised the advisor and private equity funds in connection with modifications to ownership structure, distribution rights, employment rights, indemnification, and banking issues. Pastore also assisted in substantial revisions to the advisor’s Form ADV, other SEC filings, Compliance Manual, Corporate Governance documents, and Policies and Procedures.

Pastore Obtains a Dismissal of a Large Investment Banking Case in Delaware District Court

Pastore & Dailey won a complex securities and M&A action in the United States District Court for the District of Delaware arising from a derivative rights holder agreement and related investment banking engagement agreements. This is the latest iteration in the saga between the Defendant, Pastore & Dailey’s client, and the Plaintiff, a representative of the shareholders to a company seeking to invalidate investment banking fees owed following a series of complex insurance corporate mergers.

After Pastore & Dailey successfully defended its client in the United States District Court for the District of Nebraska and then successfully defended its client in the appeal before the Eight Circuit that followed the District of Nebraska decision, its Motion to Dismiss was granted in the District of Delaware. In its Memorandum Opinion, the District Court agreed that Plaintiff’s claims were batted by the doctrine of res judicata and that the Plaintiff lacked standing to assert its claims.

Pastore & Dailey attorneys have vast experience arguing and defending matters in various federal courts across the country and are well-situated to handle similar claims involving complex contractual and investment banking issues.

Pastore Represents a Large Investment Bank in Win at the Eighth Circuit

Pastore & Dailey won a complex securities and M&A appeal taken to the United States Court of Appeals for the Eighth Circuit arising from a derivative rights holder agreement and related investment banking engagement agreements. This matter was an appeal filed by Plaintiff-Appellant after Pastore & Dailey successfully defended this case in the United States District Court for the District of Nebraska.

Plaintiff-Appellants, who were shareholders to a company, brought suit against Pastore & Dailey’s client in the District Court seeking to invalidate investment banking fees owed to Pastore & Dailey’s client following a series of complex insurance corporate mergers, in which the company was acquired and merged with another company. In its appeal to the Eighth Circuit, Plaintiff-Appellants argued that the District Court erred in denying certain Post-Judgment motions made by Plaintiffs arguing their lack of standing. The Eighth Circuit affirmed the District Court ruling in Pastore & Dailey’s favor that Plaintiff-Appellants lacked standing.

Pastore & Dailey attorneys have vast experience arguing and defending matters in various federal courts across the country and are well-situated to handle similar claims involving complex contractual and investment banking issues.

Pastore & Dailey Retained by Multi-Billion Dollar Private Equity Firm

Pastore & Dailey has been retained, in connection with an SEC investigation by one of the largest private equity firms in the world, that allows investments by retail investors. Pastore & Dailey attorneys have served as Chief Compliance Officer at multi-billion-dollar investment advisers and two of the largest banks in the world. Thus, the firm is uniquely positioned to handle this and similar matters. Pastore & Dailey attorneys have also served as General Counsel and in-house counsel of some of the largest Wall Street firms and have served as regulators at the Securities Exchange Commission (SEC), New York Stock Exchange (NYSE) and the Financial Industry Regulatory Authority (FINRA).

Pastore & Dailey Retained by Leading Cryptocurrency Firm

Pastore & Dailey has been retained by a leading cryptocurrency firm specializing in decentralized finance in connection with regulatory and compliance matters in the Cayman Islands and internationally.  Pastore & Dailey has substantial experience and the burgeoning business of cryptocurrency having represented in 2020 a cryptocurrency mining company, and defended a Department of Justice (DOJ) investigation into an initial coin offering.

Pastore & Dailey attorneys have served as Chief Compliance Officer’s at multi-billion-dollar investment advisers and two of the largest institutional banks in the world. Thus, the firm is uniquely positioned to handle this and similar matters.

Pastore & Dailey has been retained in DOJ Crypto Currency Proceeding

Pastore & Dailey has been engaged as co-counsel to an Am Law 50 Firm in a Department of Justice (DOJ) investigation into an initial coin offering. The matter is pending in the District of New Jersey and involves the creation of a Bloomberg terminal for the cryptocurrency industry. The software created by the start-up was designed to provide all data related to thousands of cryptocurrencies and the crypto trading functionality was to be provided through third parties accessible through the terminal.

Are RIAs Eligible for PPP?

Is a Registered Investment Advisor (“RIA”) eligible to participate in the Payment Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”)? The short answer is “yes.”

The PPP was promulgated as part of the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) which in part set aside hundreds of billions of dollars to help small businesses retain their employees during the COVID-19 crisis and the resultant work from home orders set forth by governors across the country.

Background

We understand that many RIAs applied for and were granted a loan under the CARES act, and that some of these RIAs may be unsure of whether they were granted the loan in error, how they may spend the loan funds or if they can spend the loan funds. The guidance below will hopefully answer some of these questions because applying for and receiving a PPP loan in a knowingly false fashion is a criminal offense, and we strongly encourage any RIA unsure of its PPP eligibility to seek particular legal advice.

The guidance below hinges on whether an RIA engages in speculative operations, holds any securities or other speculative assets, or is simply engaged in financial advisory services.

SBA Guidance

The SBA published an Interim Final Rule on April 2, 2020 (the “Interim Final Rule”). Specifically, the Interim Final Rule provides that “Businesses that are not eligible for PPP loans are identified in 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2….” (the “SOP”).

Some of the ineligible financial markets and funds businesses listed in the SOP include, without limitation:

  • Banks;
  • Life insurance companies (but not independent agents);
  • Finance companies;
  • Investment companies;
  • Certain passive businesses owned by developers and landlords, which do not actively use or occupy the assets acquired or improved with the loan proceeds, and/or which are primarily engaged in owning or purchasing real estate and leasing it for any purpose; and
  • Speculative businesses that primarily “purchas[e] and hold[ ] an item until the market price increases” or “engag[e] in a risky business for the chance of an unusually large profit.”

On April 24, 2020, the SBA issued its Fourth Interim Final Rule on the PPP (the “Fourth Interim Final Rule”). The Fourth Interim Final Rule explicitly states that hedge funds and private equity firms are not eligible for a PPP loan.

Discussion

Ineligible Companies.

If the RIA is also a hedge fund or a private equity firm, then it may not be eligible to receive a PPP loan. If, however, the RIA is legally distanced from those entities through appropriate corporate structures, and the loan is only used for the RIA business, then the RIA should be eligible to receive the PPP funds.

Because most RIAs are not also banks or life insurance companies, the exclusions should not apply. However, as some RIAs also sell life insurance products, such individual situations may require more research.

Finance companies are also ineligible under the SBA guidelines to receive PPP funds. The SBA guidelines define a finance company as one “primarily engaged in the business of lending, such as banks, finance companies, and factors.” (Sec. 120.110(b) of the SBA’s Business Loans regulations). Thus, this exclusion should not apply. Similarly, an RIA may not be deemed an investment company, which is a company organized under the Investment Company Act of 1940, unless the RIA was in fact incorporated under that Act.

An RIA also may not meet the definition of a “speculative business” as defined above in the Interim Final Rule. If an RIA does not purchase or hold assets until the market price increases or engage in a risky business for the chance of an unusually large profit, then it will not meet this definition. Speculative businesses may also include: (i) wildcatting in oil, (ii) dealing in stocks, bonds, commodity futures, and other financial instruments, (iii) mining gold or silver in other than established fields, and (iv) building homes for future sale, (v) a shopping center developer, and (vi) research and development. (Sec 120.110(s) of the SBA’s Business Loans regulations, SBA Eligibility Questionnaire for Standard 7(a) Guaranty and SOP Subpart B D (Ineligible Businesses).  It is our understanding that an RIA that merely provides portfolio management services would not be deemed to be involved in a “speculative” business based on the examples of such businesses provided by the SBA. If the SBA had taken the position that financial advisory services are speculative, it could easily have so indicated by including such services in its lists of speculative services.

Financial Advisory Services.

Consistent with this view, the SBA has provided clear guidance that financial advisory services are eligible for SBA loans, including loans under the PPP. In the SBA’s SOP, the SBA provides the following: “A business engaged in providing the services of a financial advisor on a fee basis is eligible provided they do not use loan proceeds to invest in their own portfolio of investments.” (SOP Sec III(A)(2)(b)(v) pp.104-105) (emphasis added).

This guidance is clear that the focus of ineligibility is at the portfolio company level, not the advisory level, and this is consistent with the guidance noted above making hedge funds and private equity firms ineligible. Hedge funds and private equity firms make money based upon speculative investments and/or appreciation of the markets. An investment advisor operates at the consulting or services level. In other words, the SBA has distinguished between true speculative operations such as wildcatting, speculative real estate development and investing in securities, and service-based operations such as the investment advisory business. Assuming that an eligible RIA did not use any proceeds of the PPP loan at any investment level, such RIA should not be deemed a speculative business and is eligible for a PPP loan.

SEC Guidance

SEC guidance affirms that RIAs are eligible for PPP loans. While the SEC imparts certain burdens on RIAs that accept PPP loans, the fact that the SEC even acknowledges such burdens should give most RIAs confidence that a PPP loan is available to them.

For RIAs who are eligible to receive PPP funds under the SBA guidance set forth above, the SEC instructs that they must comply with their fiduciary duty under federal law and make a full and fair disclosure to their clients of all material facts relating to the advisory relationship. The SEC further posits that “If the circumstances leading you to seek a PPP loan or other type of financial assistance constitute material facts relating to your advisory relationship with clients, it is the staff’s view that your firm should provide disclosure of, for example, the nature, amounts and effects of such assistance.” An example of a situation the SEC would require such disclosures would be an RIA requiring PPP funds to pay the salaries of RIA employees who are primarily responsible for performing advisory functions for clients of the RIA. In this case the SEC would require disclosure as this may materially affect the financial well-being of an RIA’s clients.

The SEC additionally provides that “if your firm is experiencing conditions that are reasonably likely to impair its ability to meet contractual commitments to its clients, you may be required to disclose this financial condition in response to Item 18 (Financial Information) of Part 2A of Form ADV (brochure), or as part of Part 2A, Appendix 1 of Form ADV (wrap fee program brochure). (SEC Division of Investment Management Coronavirus (COVID-19) Response FAQs).

Summary

While the Cares Act and PPP are recently enacted, and there is some confusion surrounding the eligibility requirements for the PPP, the SBA had a clear opportunity to deem financial advisors ineligible in the Interim Final Rule and Fourth Interim Final Rule, but specifically chose not to do so. Instead, the SBA followed the direction of its historical eligibility requirements, holding to ineligibility at the fund and portfolio company level, but continuing to permit loans to firms operating at the advisory level.

While it is possible that the SBA could interpret its own rules and regulations inconsistently with the specific guidance provided in the Interim Final Rule and Fourth Interim Final Rule, the weight of the evidence strongly suggests that an investment advisor is eligible for a PPP loan as long as it does not use the proceeds for fund or portfolio company purposes.

Pastore & Dailey Wins Jury Trial

Pastore & Dailey successfully concluded a contentious, multi-year litigation, defeating claims of fraudulent inducement and securities fraud brought against two hedge fund executives by a billionaire family office special purpose investment vehicle. The billionaire family office, the heirs to and founders of a well-known apparel store, had invested in the fund’s General Partner limited liability company.

In 2018, The United States District Court for the District of Connecticut granted a summary judgment in favor of the defendants. The summary judgment was subsequently appealed up to the United States Court of Appeals for the 2nd Circuit, before being remanded back to, and concluding with, a jury trial in the United States District Court for the District of Connecticut in New Haven, Connecticut. Pastore & Dailey was hired for the trial. After two weeks of evidence and 7 hours of jury deliberation, Pastore & Dailey was able to secure a favorable jury verdict for the clients.