In August 2018, the US District Court for the Northern District of California issued an order with broad implications for the cryptocurrency industry: companies headquartered abroad may nonetheless be subject to US securities laws if their activity – including server locations and blockchain validation node clusters – indicate that sales were conducted in the United States.
This decision appears to be the first time that a US court has taken blockchain infrastructure into account when assessing the applicability of US securities laws to overseas actors, and we expect it to serve as an important precedent for courts presented with similar jurisdictional challenges.
The Tezos project was the brainchild of Arthur and Kathleen Breitman, who in 2015 founded a Delaware corporation called Dynamic Ledger Solutions, Inc. (DLS) with its principal place of business in California. Two years later, the Breitmans and DLS formed a Swiss nonprofit called Tezos Stiftung (the Tezos Foundation) to oversee an ICO of digital tokens and exercise control of the proceeds.
According to the complaint, the Breitmans and DLS were heavily involved in the planning and execution of the Tezos ICO from a technical and operational perspective, "including by designing, constructing, and deploying the software underlying the ICO." In addition, the Breitmans and DLS organized and conducted a private pre-sale of the yet-to-be-issued Tezos tokens in late 2016 and early 2017 to cryptocurrency-focused hedge funds as well as several high-net-worth individuals.
The Tezos ICO took place during July 2017 and raised an estimated $109 million worth of Bitcoin and Ether within the first 15 hours. By the end of the two-week ICO, the Tezos Foundation had raised an alleged $232 million, making it one of "the largest in [the] history" of ICOs.
The "Contribution Terms" for the token sales provided that the legal site of the ICO transactions was Alderney, a remote outpost in the British Crown's Channel Islands. The Contribution Terms further stated that "the contribution procedure, the [Tezos tokens] creation and [Tezos tokens] allocation is considered to be executed in Alderney."
Class action lawsuit
In the months following the Tezos ICO, multiple plaintiffs brought lawsuits in California courts claiming violations of federal securities laws as well as violations of false advertising and unfair competition laws. On December 4, 2017, these lawsuits were consolidated into one class action – In re Tezos Securities Litigation – in the U.S. District Court for the Northern District of California. On April 3, 2018, Arman Anvari, the court-appointed lead plaintiff, filed a consolidated class action complaint alleging that the Tezos Foundation, the Breitmans, DLS, and several other parties violated U.S. securities laws – including Section 5, 12(a)(1) and 15 of the Securities Act of 1933 – by marketing or selling Tezos tokens in connection with the ICO.
In a motion filed on May 15, 2018, the Tezos Foundation, which is the only defendant alleged to have "sold" a security, challenged personal jurisdiction and the extraterritorial application of US securities laws. In relevant part, the Tezos Foundation argued under the US Supreme Court case Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), US laws do not apply extraterritorially unless expressly authorized by Congress. The Tezos Foundation argued that U.S. securities laws should not apply to it because the organization is "a Swiss entity . . . subject to Swiss law and overseen by Swiss regulatory agencies," and because it had designated Alderney as the legal site for all ICO transactions. The Tezos Foundation also argued that the relevant transactions occurred where the "contribution software" resided, which was also in Alderney.
Court's extraterritorial application of US securities laws
The court rejected the Tezos Foundation's argument that the ICO transactions occurred outside of the United States and ruled that it could exercise personal jurisdiction over the Swiss entity. The court found that the Tezos Foundation had numerous contacts within the US and that the following factors, none of which were individually dispositive, weighed in favor of a finding that the sales at issue occurred in the US:
- Targeting/sales: The plaintiff participated in the ICO from the US and learned about the ICO through "marketing that almost exclusively targeted United States residents." In addition, the Tezos Foundation had a "de facto U.S. marketing arm" – the Breitmans – based in California.
- Website hosting: The website at issue was hosted on a server in Arizona.
- Website operation/maintenance: The website was run by Arthur Breitman, who lives in California.
- Blockchain node clusters: The plaintiff's contribution only became irrevocable after it was validated by a network of global "nodes" that were "clustered more densely in the United States than in any other country."
The court noted that the Tezos Foundation "encouraged U.S. citizens to participate in the ICO, it made it easy for them to do so, and the results reflected those efforts."
In the same order, the court granted motions to dismiss by two other defendants, including a motion by Switzerland-based Bitcoin Suisse AG (Bitcoin Suisse), a company that provided intermediary services to individual Tezos ICO contributors, including the conversion of US dollars to Bitcoin and Ether, the transfer of that cryptocurrency to the Tezos Foundation, and the creation of digital wallets for the receipt of Tezos tokens. The court found that, unlike the Tezos Foundation, Bitcoin Suisse did not provide ICO services to any US investors and plaintiff could not show that, absent US-related conduct by Bitcoin Suisse, the plaintiff would not have been injured.
Implications for overseas companies
Tezos provides useful guideposts for overseas companies assessing whether they are exposed to US securities laws. Companies should recognize that US courts will consider factors beyond a business' country of incorporation and the location of its headquarters when deciding jurisdictional questions. To reduce the risk that US law will apply, overseas companies should:
- Evaluate whether any of their activities, such as the promotion of digital assets, are targeted to or directed at individuals in the United States and whether sales are open to individuals located in the United States. Based on the allegations in the complaint, the Tezos Foundation does not appear to have taken any measures – such as blocking or geofencing US-based IP addresses – to prevent individuals located in the US from purchasing Tezos tokens.
- Recognize that purchase terms designating a particular jurisdiction as the legal site for digital asset transactions do not automatically govern in the event of a dispute. Rather, courts are likely to focus on the actual – not the contractual – situs of the transactions.
- Consider technical touchpoints, including the locations of their servers and blockchain infrastructure. The situs of blockchain nodes at the time of validation and recordation could affect how a court determines whether the transaction at issue occurred in the US.
Find out more about this ruling by contacting any of the authors.
An earlier version of this article appeared on Law360 on October 26, 2018.