U.S. Federal Lawsuit by Mt. Gox Customers Cannot Proceed as a Class Action

On February 24, 2014, the Mt. Gox bitcoin exchange went offline following a series of hacks through which tens of thousands of bitcoin were stolen. Following Mt. Gox’s collapse, regulators, prosecutors, and civil plaintiffs pursued Mt. Gox and related individuals to seek to hold responsible parties to account. Among those actions was a purported class action filed in the United States District Court for the Northern District of Illinois, on behalf of a purported class of more than 30,000 Mt. Gox customers against, among others, Mt. Gox and Mark Karpeles (Mt. Gox’s principal). See Greene v. Karpeles, Case No. 14 Civ. 1437 (N.D. Ill.) (filed Feb. 27, 2014). The case has a lengthy history, but in its present incarnation it has one defendant—Karpeles—and a sole plaintiff—Greene—who sought to certify a class of Mt. Gox customers. On June 22, 2021, the Honorable Gary Feinerman denied that request. Click here for a copy of Judge Feinerman’s Memorandum Opinion and Order.

By way of background, in early 2012 Mt. Gox posted Terms of Use on its website. Mt. Gox customers were required to accept the Terms of Use as a condition of using the exchange. But that doesn’t mean that every customer read the Terms of Use when they accepted them, or any time thereafter for that matter. Plaintiff Greene contends he did, and that he relied on certain representations in the Terms of Use when he used the exchange. But to determine if every other member of the proposed class similarly read the Terms of Use would require making an individual inquiry of each of those purported class members.

And that gets to the heart of this decision. Class certification in federal court is governed by Rule 23(a) of the Federal Rules of Civil Procedure. Before a class may be certified, it must satisfy the four requirements of Rule 23(a): “(1) the class is so numerous that joinder of all members is impracticable; (2) there are questions of law or fact common to the class; (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class; and (4) the representative parties will fairly and adequately protect the interests of the class.” In addition, the proposed class must satisfy one of the categories in Rule 23(b); as applicable here, it must be “a case in which the common questions predominate and class treatment is superior.” Where the questions of law or fact common to class members do not predominate over any questions affecting only individual members, then the proposed class does not satisfy the predominance requirement.

In the Mt. Gox case, the underlying claim is one for common law fraud. “Greene’s theory of fraud is that the Mt. Gox Terms of Use falsely represented that Mt. Gox held all assets on its users’ behalf and that trades involved actual assets, that Karpales knew those representations were false and intended to deceive Mt. Gox users, and that the users kept assets on Mt. Gox in reliance on Karpeles’s misrepresentations.” (emphasis added). But in order to have relied on Karpeles’s misrepresentations, each member of the class must have read the Terms of Use, or at least have been aware of the relevant provisions of the Terms of Use, and that the relevant Terms influenced their actions. Absent a presumption of reliance applicable to the class—and no such presumption existed in this case—reliance is individualized, that is, the court would have to make a determination of reliance with respect to each member of the class individually. “Holding over thirty thousand mini-trials to determine how each class member understood and whether each class member relied upon a contract they accepted nearly a decade ago would present insurmountable difficulties.” Judge Feinerman concluded, as a result, that common issues do not predominate and, therefore, class certification was not appropriate.

Decisions granting or denying class certification often are fact specific and do not garner much attention beyond the case in which the decision is made. But the Mt. Gox case is worthy of note for at least two reasons. First, the decision is among a very small group of cases examining class certification in the crypto context. It is worthwhile to watch the development of the law in this nascent area. Second, and more practically, when a court grants certification in a class action, it is an important victory for the class because it often forces the defendants to come to the bargaining table and settle soon thereafter. Conversely, when defendants defeat class certification—which, absent a change on appeal or an amended pleading, means the case can move forward with only the named plaintiff—it is an important victory for the defendants because it drastically reduces the liability landscape the defendants face and often brings a fairly quick close to the litigation.

SEC, Targeting Promoters, Enters the BitConnect Fray

The SEC last week sued several alleged promoters connected with BitConnect, accusing the individuals of participating in or aiding and abetting the offering of unregistered securities in violation of Section 5 of the Securities Act of 1933 and Section 15(a) of the Securities Exchange Act of 1934, and doing so without being registered as broker-dealers, as required by the federal securities laws. See SEC v. Brown, et al., No. 21 Civ. 4791 (JGK) (S.D.N.Y. May 28, 2021). According to the SEC, between January 2017 and January 2018, BitConnect, directly and through the named defendant promoters, solicited investors to participate in its “lending program,” whereby investors invested bitcoin with BitConnect in exchange for interest payments derived from value generated by a trading bot focused on profiting from the volatility of Bitcoin. According to the complaint, BitConnect guaranteed a “high rate of return” (as high as 40% per month) with “no risk” from the “safe” investment. The SEC contends the promoters—including U.S.-based Trevon Brown (a.k.a. Trevon James), Craig Grant, Ryan Maasen, and Michael Noble (a.k.a. Michael Crypto)—used social media and other communications to plug the lending program in return for referral commissions—a percentage of each investment resulting from their individual efforts and the efforts of their referral network. The SEC alleges that successful promoters also received so-called “development funds” that they could use for themselves or pass on to investors in their network. According to the complaint, the promoter defendants named in the lawsuit earned referral commissions and development funds ranging from more than $475,000 to $1.3 million. Another defendant, who allegedly served as the liaison between Bitconnect and the promoters, earned more than $2.6 million. The SEC seeks injunctive relief, disgorgement plus interest, and civil penalties. According to the SEC, its investigation is ongoing.

BitConnect’s legal troubles began in early 2018 when various state regulators, including Massachusetts and Texas) opened investigations and proceedings on BitConnect. At the same time, numerous investors filed lawsuits in federal court in Florida against BitConnect and some of the same promoters sued by the SEC last week. Those civil cases, which were consolidated, fell victim to multiple successful motion to dismiss and currently are on appeal to the Court of Appeals for the Eleventh Circuit.

What can we infer from the timing of the SEC’s lawsuit? Perhaps not much. BitConnect has been condemned variously as a Ponzi scheme, a scam, a fraud, and evidence of the “common knowledge” that the Bitcoin market is being manipulated. BitConnect, then, would seem a likely candidate for the SEC’s attention. It may seem curious that the SEC’s complaint comes more than three years after state regulators and private litigants focused their efforts on BitConnect. That could simply be a function of the time required to conduct the investigation. In its press release contemporaneous with the filing of the lawsuit, the SEC thanked “the Cayman Islands Monetary Authority, the Hong Kong Securities and Futures Commission, the Monetary Authority of Singapore, the Ontario Securities Commission, the Romanian Financial Supervisory Authority, and the Thailand Securities and Exchange Commission.” That is a lot of helping hands. Or perhaps the SEC has other developments on its mind. There are several applications for Bitcoin exchange-traded funds (ETFs) currently pending before the SEC, and the SEC has previously denied similar applications, inter alia, because of concerns about manipulation in the market for Bitcoin. So perhaps the timing is not so curious. Then again, the conduct at issue in the SEC’s lawsuit occurred in 2017-2018, making any connection to the state of the current market for Bitcoin more tenuous. At the very least, one must keep in mind the SEC’s mission to protect investors and maintain fair, orderly, and efficient markets; the SEC’s case against BitConnect reaffirms that one cannot assume that conduct well in the past has flown below or escaped the SEC’s pursuit of its mission.

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The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

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