SDNY Certifies Class in Major Crypto Case

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The Southern District of New York recently certified a class action involving allegations of market manipulation in the cryptocurrency sector. Judge Katherine Polk Failla’s certification order addresses one of the key challenges in this type of litigation: the intersection between limits on the extraterritorial application of U.S. regulatory law and the requirements for class certification under Rule 23(b).

Background

The plaintiffs in In re Tether & Bitfinex Crypto Asset Litigation are purchasers of Bitcoin and other cryptocurrencies, as well as cryptocommodity futures. They sued a group of defendants involved with Tether, the issuer of a stablecoin called “USDT,” and its sister company Bitfinex, a crypto asset exchange.

Tether had represented that USDT was backed 1:1 by U.S. dollars and guaranteed to be redeemable for cash. The plaintiffs alleged that the defendants debased these crypto assets by issuing hundreds of millions of USDT without in fact holding equivalent amounts of U.S. dollars. (These allegations were supported by earlier regulatory investigations of Tether and Bitfinex: both the Commodity Futures Trading Commission and the New York State Attorney General had fined Tether for making misleading statements regarding the assets held on deposit to back USDT.)

The plaintiffs further alleged that the defendants had used the debased crypto assets to manipulate prices in the market for cryptocommodities. According to their complaint,

Defendants engaged in a sophisticated scheme to artificially inflate the price of cryptocommodities by purchasing bitcoin and other cryptocommodities with USDT that was not fully backed by U.S. dollars when the price of bitcoin was falling, creating the illusion of increased demand for cryptocommodities, and thus driving up cryptocommodity prices.

The named plaintiffs had purchased Bitcoin and other crypto assets; one had also purchased Bitcoin futures. They brought claims under both the Sherman Act (based on the cryptocommodity purchases) and the Commodity Exchange Act (CEA) (based on the futures purchases). The plaintiffs sought certification of (a) a class defined to include purchasers of crypto-commodities (“including Bitcoin, Bitcoin Cash, Ethereum, Ethereum Classic, Litecoin, Monero, Dash and ZCash”) or cryptocommodity futures in the United States and (b) a sub-class including purchasers of crypto-commodity futures in the United States.

The reason the plaintiffs limited the proposed class to purchasers of crypto assets in the United States is that the CEA does not apply extraterritorially: only claims arising from domestic transactions fall within its scope. But establishing “domesticity” is no easy task when it comes to transactions in cryptoassets, due to the decentralized, globally distributed nature of the market. This presents a challenge for plaintiffs seeking to certify a class of purchasers transacting in a wide range of cryptocommodities across a wide range of trading platforms.

Certification Challenges

One of the requirements for certifying Rule 23(b)(3) class actions is that the questions of law or fact common to all class members must predominate over questions that affect only individual members. This “predominance” requirement can create particular challenges in securities and commodities litigation because it intersects with the geographic limitations of U.S. regulatory law.

Under the Morrison framework for claims under the Securities and Exchange Act, which the Second Circuit has also adopted, in modified form, for claims under the CEA, determining whether a purchaser’s claim falls within the scope of U.S. law turns on transaction-specific facts—such as the location of the exchange on which the purchaser transacted, or, for non-exchange based transactions, the location where title passed or irrevocable liability was incurred. Those facts can vary significantly across putative class members. As a result, courts may conclude that individualized evidence is needed to establish domesticity, overwhelming common questions about misrepresentation or market impact.

Domesticity Under the CEA

The district court began with the CEA claims—that is, the claims based on injuries related to the purchase of cybercommodity futures. Under Second Circuit precedent, in order to fall within the scope of the CEA’s application, a claim must (a) allege domestic conduct in violation of the CEA and (b) arise in connection with “transactions occurring in the territory of the United States.” The court found no difficulty in establishing commonality regarding the first prong of this test: the question whether the defendants had engaged in sufficient domestic conduct was common to all plaintiffs. The second prong, though, is more difficult.

Adapting Morrison to the Commodity Exchange Act

For claims asserted under the Securities and Exchange Act, Morrison lays out two separate tests to establish whether a transaction occurred in the United States. These are linked to the language in the Act: Section 10(b) prohibits deceptive conduct “in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered.” Accordingly, the first test applies to exchange-based transactions. There, the analysis is straightforward: transactions on U.S. exchanges are domestic; transactions on foreign exchanges are not. The second test applies to non-exchange-based transactions, where the inquiry is more complicated. This test, initially developed in the Absolute Activist case, looks to whether irrevocable liability was incurred or title was transferred within the United States—a fact-specific determination that can become incredibly complicated based on the transaction type.

The Commodity Exchange Act’s anti-fraud provisions, by contrast, do not refer to exchanges. Section 6(c)(1) prohibits manipulation in connection with certain types of transactions, and Section 22 allows a private right of action against a person whose violation of the CEA “result[s] from one or more of the transactions” listed in that section. As a result, as the Second Circuit has stated, only the second prong of the Morrison test has been applied to claims asserted under the CEA. Following Absolute Activist, courts inquire whether irrevocable liability was incurred or title was transferred in the United States. Given the context of commodity trading, that inquiry involves investigation into questions like where contracts were formed; where orders were placed; where trades were matched; etc.

Within this framework, the fact that a transaction occurred on an exchange outside the United States is not determinative. Indeed, the Second Circuit stated explicitly in Choi v. Tower Research that if irrevocable liability is incurred in the United States, the CEA can apply to a claim arising from a transaction on a foreign exchange.

Application

Judge Failla began by dividing the putative class members into three categories: (1) those who had bought futures on domestic exchanges; (2) those who had bought them on foreign exchanges; and (3) those who had bought them on “stateless” exchanges—a problem particular to cyber assets.

She concluded that Category 1 presented no difficulty. Citing the Second Circuit’s holding in In re Platinum and Palladium Antitrust Litigation that “[transactions] on a domestic futures exchange are domestic transactions,” she held that purchases on domestic exchanges qualified as domestic and would therefore require no individualized analysis.

Turning to Category 2, Judge Failla stated that the question of domesticity when U.S.-based purchasers transact on foreign exchanges is “much thornier” in that the purchasers would have to “show evidence of domesticity that would vary depending on the specifics of the transaction”—requiring the court to consider facts “concerning the formation of the contracts, the placement of purchase orders, the passing of title,” and so forth. As a result, she concluded, individual issues would predominate. For that reason, she modified the proposed class and futures subclass to remove cryptocommodity futures purchased on foreign exchanges. (Although Judge Failla didn’t mention the comity implications of Category 2 cases, they weigh in favor of this modification: applying U.S. law to transactions on exchanges within the regulatory purview of another country would tend to create the kind of conflict Morrison sought to avoid.)

Finally, Judge Failla considered the characterization of transactions on “stateless” exchanges. As she explained, in an earlier case, the Second Circuit had held that

when an exchange had “not registered in any country,” had “no physical or official location whatsoever,” and was “not … subject to the oversight of any country’s regulatory authority,” applying U.S. law was appropriate if either (i) the trades at issue were matched on servers in the United States, or (ii) plaintiffs had placed their orders, agreed to the exchange’s terms of use, and sent payments, all from the United States, and the exchange’s terms of use prohibited them from revoking the orders once placed.

The defendants argued that this test too would require individualized analysis to determine whether each purchaser within the putative class could establish a domestic transaction. Judge Failla disagreed. She held that the relevant analysis could be conducted exchange by exchange rather than purchaser by purchaser. That was enough, in her view, to satisfy the predominance requirement.

Putting these pieces together, Judge Failla shaped the futures subclass to include “those who bought Class Assets from the United States on either (i) U.S. exchanges or (ii) non-U.S. exchanges that were not subject to any other country’s regulation and that either (a) matched trades on servers in the United States or (b) prohibited buyers from revoking their orders once placed.”

The Antitrust Claims

These presented no difficulty regarding the Rule 23 analysis. Unlike the CEA, the antitrust regime recognizes “effects” jurisdiction. Under the FTAIA, foreign conduct that has effects within the United States that cause domestic antitrust injury fall within the scope of the law. As a result, the court stated, “Whether the exception applies depends on the effect of the crypto-economy on American commerce, which is a question common to the Class. It thus does not bar class certification (or even require a narrowing of class definitions).”

Conclusion

Establishing the domesticity of transactions in crypto assets necessarily involves complex factual determinations that may vary among members of a large plaintiff class. Nevertheless, those difficulties should not completely block class actions by victims of crypto fraud. In this order, Judge Failla charted a middle course, doing exactly what the Second Circuit suggested in In re Petrobras Securities:

[W]e emphasize that district courts are authorized to implement management strategies tailored to the particularities of each case.  In addition to modifying class definitions and issuing class‐wide rulings, district courts can, for example, … certify subclasses that separate class members into smaller, more homogenous groups defined by common legal or factual questions.