Second Circuit Allows Securities Claims Against Crypto-Asset Exchange
May 14, 2024
In Morrison v. National Australia Bank (2010), the U.S. Supreme Court applied the presumption against extraterritoriality to § 10(b) of the Securities Exchange Act, holding that this provision applies only to transactions in the United States. Morrison’s transactional test has proven difficult to apply to unlisted securities that do not trade on an exchange. In Williams v. Binance, the Second Circuit faced an extreme version of this difficulty because the defendant Binance, an online platform for crypto assets, claimed to have no physical location at all.
Writing for the Second Circuit panel, Judge Alison Nathan held that Binance was nevertheless subject to U.S. securities laws. “Even if the Binance exchange lacks a physical location,” she wrote, “the answer to where th[e] matching [of trades] occurs cannot be ‘nowhere.’” Because Binance used servers located in the United States, and because the plaintiffs placed trades from within the United States, the court concluded that the transactions were domestic. So far, so good.
But the court of appeals applied Morrison’s transactional test to provisions of federal securities law other than § 10(b), ignoring the different language of those provisions as well as the Supreme Court’s instruction to determine the geographic scope of federal statutes provision-by-provision. The Second Circuit also mistakenly applied Morrison’s transactional test to the plaintiffs’ state law claims. Some states have presumptions against extraterritoriality, but others do not. And even those states that have such presumptions sometimes apply them differently than the U.S. Supreme Court.
The Claims
Binance is an online platform for crypto assets. It was founded in China but moved its headquarters to Japan and then to Malta. Binance claims to have no physical location, but it does have servers, employees, and customers in the United States. Binance has not, however, registered as a securities exchange or a broker-dealer in the United States.
The plaintiffs bought “security tokens” on Binance. These tokens are issued to raise capital. They provide the token holder with a future interest in the issuer’s project but do not give the token holder ownership or a creditor interest in any corporate entity. For purposes of the appeal, Binance did not dispute that the tokens at issue are “securities” within the meaning of federal and state securities laws.
When the tokens lost most of their value, plaintiffs filed suit on behalf of themselves and a class of similarly situated purchasers. Plaintiffs sought damages based on the sale of unregistered securities under § 12(a)(1) of the 1933 Securities Act. Plaintiffs also sought to rescind their purchases under § 29(b) of the 1934 Securities Exchange Act because Binance had not registered as a securities exchange or broker-dealer. Finally, plaintiffs brought claims under the state securities laws—commonly known as “Blue Sky” laws—of 49 states, the District of Columbia, and Puerto Rico.
The Location of the Transactions
As noted above, Morrison adopted a transactional test for § 10(b) of the Exchange Act, holding that it applies only to transactions that occur in the United States. For unlisted securities that do not trade on an exchange, the Second Circuit held in Absolute Activist Value Master Fund Ltd. v. Ficeto (2012) that a transaction occurs where title passes or where “irrevocable liability” is incurred—that is, where a party becomes legal bound to the transaction.
In a subsequent case involving trades on an electronic exchange, Myun-Uk Choi v. Tower Research Capital LLC (2018), the Second Circuit applied the irrevocable liability prong of this test to hold that trade offers became irrevocable when they were matched with offers from counterparties. Because the exchange in Choiwas located in the United States, the transactions were domestic.
In this case, Binance claimed that its exchange has no physical location. But the court of appeals concluded that the transactions occurred in the United States based on the physical location of Binance’s servers. “While it may not always be appropriate to determine where matching occurred solely based on the location of the servers the exchange runs on,” Judge Nathan wrote, “it is appropriate to do so here given that Binance has not registered in any country, purports to have no physical or official location whatsoever, and the authorities in Malta, where its nominal headquarters are located, disclaim responsibility for regulating Binance.”
The Second Circuit also held that these transactions were domestic for a second reason. Plaintiffs placed trades and made payments from within the United States. Under Binance’s Terms of Use, plaintiffs were unable to revoke their trades unilaterally once they were placed. Thus, plaintiffs incurred irrevocable liability in the United States.
After addressing some statute-of-limitations and class-member issues that I will not discuss, the court of appeals reversed and remanded to the district court for further proceedings.
Does Morrison’s Transactional Test Apply to Other Federal Claims?
The Second Circuit’s decision never really grappled with whether Morrison’s transactional test applies to the provisions of federal securities law at issue in this case or to the plaintiffs’ state law claims. The court disposed of these questions in a single sentence:
Although Morrison involved the Exchange Act, we have applied a similar framework to Securities Act claims as well as claims under state Blue Sky laws. See Univs. Superannuation Scheme Ltd. v. Petróleo Brasileiro S.A. Petrobras (In re Petrobras Sec.), 862 F.3d 250, 259 (2d Cir. 2017) (Securities Act); Fed. Hous. Fin. Agency v. Nomura Holding Am., Inc., 873 F.3d 85, 156–58 (2d Cir. 2017) (state Blue Sky laws).
In Morrison, the transaction occurred abroad, although the fraud occurred in the United States. The Supreme Court concluded that § 10(b) focuses on the transaction rather than the fraud in large part because of the provision’s language. “Section 10(b) does not punish deceptive conduct,” Justice Scalia wrote, “but only deceptive conduct ‘in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered.’”
The language in § 12(a)(1) of the Securities Act is different. Rather than referring to the “purchase or sale” of securities, as § 10(b) of the Exchange Act does, § 12(a)(1) imposes liability on anyone who “offers or sells” unregistered securities (emphasis added). Because of this difference, applying § 12(a)(1) should be considered domestic if either the transaction or the offer occurs in the United States. Put another way, a domestic transaction should not be required so long as the offer to sell unregistered securities occurs here.
I am aware of only one decision to have considered a similar difference in language when determining the geographic scope of a securities law provision—SEC v. Goldman Sachs & Co. (2011), a district court case interpreting § 17(a) of the Securities Act. And Judge Nathan is technically correct that the Second Circuit previously applied Morrison’s transaction test to provisions of the Securities Act, including § 12, in In re Petrobras Securities (2017). But the prior case similarly did so without analysis and without considering the differences in the language of the two provisions.
Plaintiffs also sought recission under § 29(b) of the Exchange Act, which provides that “[e]very contract made in violation of any provision of this chapter or of any rule or regulation thereunder … shall be void.” This, it seems to me, is a remedial provision. As in WesternGeco LLC v. ION Geophysical Corp. (2018), the focus of such of a remedial provision will tend to be the underlying violation of the statute. And so, the geographic scope of § 29(b) should mirror the scope of the alleged Exchange Act violations.
It is not clear that applying Morrison’s transactional test to the other provisions of federal law at issue makes a difference in this case. If Morrison’s transactional test is satisfied, then § 12(a)(1) likely applies because of the word “sells,” and the provisions of the Exchange Act underlying plaintiffs’ § 29(b) claims probably apply too. My point is simply that courts, including the Second Circuit in this case, have been too quick to say that the same transactional test applies to every provision of federal securities law. This not only ignores the different language that Congress employed in different provisions. It also ignores the Supreme Court’s clear mandate that courts must determine the geographic scope of federal statutes provision-by-provision.
Does Morrison’s Transactional Test Apply to State Law Claims?
Applying Morrison’s transactional test to plaintiffs’ state law claims is a more serious error. The Second Circuit cited an earlier decision, Federal Housing Finance Agency v. Nomura Holding America, Inc. (2017), as having applied Morrison’s transactional test to state Blue Sky laws. But the earlier decision seems to have done so only because the Blue Sky laws at issue—those of the District of Columbia and Virginia—themselves required transactions within their jurisdictions.
As the Restatement (Fourth) of Foreign Relations Law states in § 404 reporters’ note 5, “the geographic scope of State statutes is a question of State law.” Not all states have adopted presumptions against extraterritoriality. In a 2020 article, I counted twenty states that had embraced such a presumption, seventeen states that had rejected such a presumption, and thirteen states in which the situation was unclear.
Moreover, even when a state has adopted a presumption against extraterritoriality, it may apply that presumption differently from the federal presumption. California, for example, applied its presumption against extraterritoriality to its Blue Sky law in Diamond Multimedia Systems, Inc. v. Superior Court (1999) and held that its antifraud provisions applied when fraud occurred in California even when the transaction did not. Morrison, of course, subsequently held that the federal antifraud provision in § 10(b) does not apply whenever fraud occurs in the United States—§ 10(b) additionally requires a transaction in the United States. So, despite the fact that both California courts and federal courts apply a presumption against extraterritoriality to their respective securities laws, they have interpreted those laws differently.
One cannot, therefore, simply apply Morrison’s transactional test to state Blue Sky laws. Morrison’s transactional test is the result of applying a federal rule of statutory interpretation to a specific provision of a federal statute. States have different rules of statutory interpretation, and their statutes sometimes contain different language. In Williams v. Binance, determining the geographic scope of state Blue Sky laws is certainly a challenge because plaintiffs have brought claims under the laws of 49 states, the District of Columbia, and Puerto Rico. But this is not a challenge that federal courts may avoid by assuming that state laws are identical to federal ones.
Conclusion
Justice Scalia no doubt thought that he was simplifying the law greatly in Morrison when he adopted a transactional test for § 10(b) claims. And so he did for securities that trade on an exchange. But Morrison’s transactional test has been difficult to apply to unlisted securities like those in Williams v. Binance. And it may be completely inappropriate for claims under other provisions of federal securities law and under state law.