On February 1, 2023, Judge Paul A. Engelmayer of the United States District Court for the Southern District of New York dismissed a putative class action against a cryptocurrency exchange company, its parent, and the parent’s CEO, asserting claims under Section 12(a)(1) of the Securities Act of 1933, Section 29(b) of the Securities Exchange Act of 1934, and certain California, Florida, and New Jersey statutes. Underwood v. Coinbase Global, Inc.,—F. Supp. 3d—, 2023 WL 1431965 (S.D.N.Y. 2023). Plaintiffs alleged that the company sold or solicited securities, and entered into contracts to buy and sell securities, without registering as an exchange or broker-dealer. The Court held that, even if cryptocurrencies were deemed securities, plaintiffs failed to adequately allege that the company itself sold or solicited cryptocurrency tokens to or from exchange participants, or that any contract with the company required plaintiffs to purchase or sell prohibited securities.
With respect to plaintiffs’ Securities Act allegations, the Court analyzed whether the company qualified as a “statutory seller” by either (1) directly selling a security to plaintiffs (requiring that the company “passed title” in cryptocurrency tokens to plaintiffs as the “immediate seller”), or (2) actively soliciting the sale of a security to plaintiffs for its financial gain. Id. at *5-6 (citing Pinter v. Dahl, 486 U.S. 622, 642, 647 (1988)). The Court assumed, for purposes of its analysis, that the cryptocurrencies were “securities,” but still held plaintiffs’ allegations deficient.
To argue that the company was a direct seller, plaintiffs pointed to allegations in their amended complaint that the company held its customers’ cryptocurrency tokens in a centralized virtual “wallet,” that the customers were “not in privity” with each other, and that the customers “transact[ed] solely with [the company] itself.” Coinbase, 2023 WL 1431965, at *6. The Court noted that, although such allegations “would ordinarily assist plaintiffs in pleading” that a defendant was a statutory seller, the amended complaint was contradicted by other allegations in plaintiffs’ original complaint. For example, the Court observed that the original complaint had alleged that the company’s customers could choose to “enter into trade agreements with other [exchange] users for purchases and sales of digital assets.” Id. at *7. Moreover, the Court emphasized that the company’s User Agreement—which the original complaint referenced and plaintiffs themselves filed with the Court as part of a separate motion seeking to avoid arbitration—expressly provided that title to customers’ cryptocurrency tokens “shall at all times remain with [the user] and shall not transfer to [the exchange]” and that customers “are not buying [cryptocurrency] from [the exchange] or selling [cryptocurrency] to [the exchange]” but rather that the company “acts as the agent, transacting on your behalf, to facilitate that purchase or sale between you and other [exchange] customers.” Id. at *8. The Court therefore concluded that it “need not, and does not, accept the [amended complaint’s] contrary allegations, which unavoidably emerge as strategically added to elude the facts pled in the [original] Complaint and contained in the User Agreement that checkmate plaintiffs from adequately pleading the first prong of Pinter’s statutory seller inquiry.” Id.
The Court further concluded that plaintiffs failed to adequately allege that the company “solicited” plaintiffs’ purchases. The Court explained that although a defendant could be deemed a statutory seller based on “direct and active participation in the solicitation of the immediate sale,” plaintiffs’ allegations—that the company provided users with descriptions of different cryptocurrency tokens, provided certain free tokens as promotions, and wrote certain news updates and provided website links to others—were too “collateral” to amount to solicitation under the Securities Act. Id. at *9. Moreover, the Court observed that actionable solicitation would also require plaintiffs to have purchased or sold a security as a direct result of defendant’s alleged solicitations, which plaintiffs failed to allege. Id.
In addition, the Court held that plaintiffs failed to adequately allege a claim under Section 29(b) of the Exchange Act, which provides for the voiding of contracts that, if performed, would violate other provisions of the Exchange Act. While the parties disputed whether a private right of action was available, the Court rejected for lack of factual support plaintiffs’ theory that purchases and sales on the exchange “constitute individual contracts that are voidable.” Id. at *11. Rather, the Court further observed that, “[a]s pled, the only contract capable of rescission here under Section 29(b) is the User Agreement,” because the original complaint had alleged that plaintiffs purchased securities “pursuant to” the User Agreement. Id. at *12. The Court concluded that the User Agreement was not voidable because even if, as plaintiffs alleged, certain transactions in certain assets were prohibited, the User Agreement did not require any user to engage in such transactions. Id.
Having dismissed the claims for primary violations of the Securities Act and Exchange Act, the Court likewise dismissed plaintiffs’ claims for control person liability. Id. Moreover, the Court concluded that leave to amend would be futile, because plaintiffs had already amended their complaint, used that opportunity to add allegations that “directly contradicted their initial Complaint,” and failed to show how the deficiencies identified by the Court could be cured. Id. at *13. With respect to plaintiffs’ state-law claims, however, the Court declined to exercise supplemental jurisdiction and noted that dismissal of those claims was therefore without prejudice. Id.
