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New York, May 2018. CoinDesk and The Hilton Midtown have prepared for around 4,000 attendees at the Consensus Blockchain Technology Summit. But they came in greater numbers… well over 8,000 people mill and shill around the overheated lobby, and procuring a fresh bagel may be tougher than raising a couple of million for a hypothetical dApp.

Something isn’t quite right though. For the first time in a year, the celebratory atmosphere at a major conference carries the faint aroma of desperation. Those in the know have every reason to suspect that the ICO party is coming to an end. The Lamborghinis are rented – and the time is borrowed, too.

According to a complaint filed in the California District Court by Nirvana Capital and Winslow Strong, this is where they lost their millions.

The complaint, prepared by blockchain attorney Ryón Nixon, alleges that Mobile Gaming Technologies, Mike Reaves, George Weinberg, and Fred Hsu a/ defrauded the plaintiffs and b/ created and ran an Initial Coin Offering (ICO) that defied long-standing Securities and Exchange Commission regulations.

And this time, the investors aren’t waiting for the SEC to intervene.

A Civil Suit Based On The Howey Test

The most notable Howey-based enforcement so far was the SEC’s sanctioning of Airfox and Paragon for selling unlicensed securities. Although the punishments did not include criminal charges – each received a $250,000 fine, and they were ordered to return to compliance and return funds – the cases have set a precedent that could potentially be used in civil court to claim damages from non-compliant token offerings.

And that’s exactly what the plaintiffs seek in their case against Mobile Gaming Technologies, the company behind the CashBet token – with the added bonus of a request for ‘compensatory and punitive damages’ , in addition to a rescission order that would presumably return their investment.

CashBet describes itself as “The world’s most complete crypto-ready iGaming platform” on its website. The site goes on to explain that “CashBet is a profitable, mobile-first iGaming platform for real money, social, and skill-based gaming.”

In an ICO conducted from the 24th January 2018 until 27th April 2018, CashBet raised $38M. Touting a high-profile sponsorship deal with Arsenal Football Club and claiming 4.25 million monthly active players*, the company claimed that “our token is engineered to provide long-term value”.

Since the launch of that token, however, the value of the CashBet CBC digital asset has plummeted from a peak of $0.57 in June of 2018 to the current price of just over $0.01 – a 98% drop. (Data from CryptoCompare.com)

With the investors’ hopes dashed and their money all-but-gone, a case built on allegations of fraud might have been the only remaining chapter in this saga.

After all, like many who signed up to fund business development through the ICO model, the plaintiffs put their signatures to a complicated document with a litany of disclaimers that expressly stated “CashBet Coin do not have any functionality or utility outside the CashBet Platform.”

Moreover, the signed documents explained at great length the risks associated with purchasing the tokens, including, for instance: “It is likewise difficult to predict how or whether any governmental authority may make changes to existing laws, regulations and/or rules that will affect cryptographic tokens, digital assets, blockchain technology, and its applications. Such changes could negatively impact CashBet Coin in various ways, including, for example, through a determination that CashBet Coin are regulated financial instruments that require registration or through the imposition of onerous liquidity requirements.”

The purchaser in this instance acknowledged that the token was “Not an Investment”. They acknowledged that it was “Not for Speculation”. They signed up knowing that “The Purchase of CashBet Coin… does not provide Purchaser with any rights of any type with respect to CashBet or its revenue or assets…”

These types of legal documents have become infamous within the cryptocurrency industry.

In many instances, an investor might skip an opportunity that demanded they sign away many of the protections Angels seek when they fund an early-stage company. But the fear of missing out (FOMO) was still pungent in New York in May, and there were plenty of people willing to trade their grandmother – even their tickets to Hamilton – for a chance to make dizzying cash.

Those who crafted these types of contracts were skilled attorneys who went to great lengths to cover every possible contingency to protect their clients, the token issuers.

But no matter how airtight the contract, it’s no defense against fraud (as is alleged in this case) or against the might of the SEC, which has already proven that its enforcement role supersedes any attempt by the ICO issuer to hedge against investor refunds from civil complaints.

Section 12(a)(1) of the Securities Act allows for a civil suit in the event that the issuer of the security in question is in violation of Section 5 of that act – and that section covers running an unregistered securities offering, which is the precise violation that ensnared Paragon and Airfox.

In a statement to Crypto Briefing, a CashBet spokesperson noted that “We have reviewed the complaint entitled Nirvana Capital Limited, et al. vs. Mobile Gaming Technologies, Inc., et. al (USDC Case No. 18-cv-07483), and believe the allegations are meritless. We intend to vigorously defend against these baseless claims and will not be commenting further at this time.”

Baby Steps To ICO Investor Lawsuits

Whether or not there was fraud involved in the representation of CashBet to its investors – and whether or not the investors may have been hasty in handing over millions of dollars – the fact that a U.S.-based attorney is ready to take on a comprehensive SAFT (Simple Agreement for Future Tokens) with KYC procedures is important, and may take the CashBet suit beyond previous ICO complaints such as the one against business another that filed for a Regulation D exemption, Unikrn, in which KYC was alleged to be negligible.**

It’s worth noting that the Unikrn suit also points out that registering a utility token under a securities exemption may be seen as spurious. Crowdfund Insider’s JD Alois wrote a deeper explanation of this, and the seemingly irreconcilable matters of seeking a securities exemption while almost immediately releasing tokens onto a cryptocurrency exchange.

The first legal hurdle, the one that previously stood in the way of investor suits against SAFT-protected ICO projects, has seemingly been demolished. Fraud was not publicly alleged against either Paragon or Airfox; yet they were non-compliant. A civil suit up against a well-written SAFT may well have failed – but with the SEC nudging that barrier out of the way, there now appears to be a pathway to a civil action.

Steven Pelkin of the SEC’s Enforcement Division noted that “By providing investors who purchased securities in these ICOs with the opportunity to be reimbursed and having the issuers register their tokens with the SEC, these orders provide a model for companies that have issued tokens in ICOs and seek to comply with the federal securities laws.”

We may not know whether Paragon or Airfox had other worries on their minds when they consented to this agreement. What we do know, is that they may have preempted investor-led civil action by being proactive in their promise to rectify the harm to their funders.

Since the SEC does not want to stifle innovation, and yet cannot be seen to tolerate flagrant disregard for its rules, the penalty makes sense. It stings, but doesn’t kill either project; and it gives others a path to compliance.

A Torrent Of Investor-Led Claims Against ICO Projects?

It might be argued that the SEC decision will not allow for a District Court to make a judgement on what is, and what is not, a security – that such a determination can only be made by the SEC itself.

However, a district judge in Brooklyn, Raymond Dearie, ruled in September that “a reasonable jury should be able to apply what’s known as the Howey Test” and that “Though ‘investment contract’ has not been defined by Congress, the test for whether a “given financial instrument or transaction constitutes an ‘investment contract’ under the federal securities laws,” has long been settled.”

While the filing from Nixon’s Horizons law firm and co-counsel Aaron Zeisler may not ultimately settle a path to investor lawsuits – the fraud allegations could muddy the water – it’s clear that judicial and enforcement decisions have at least raised the specter of investor-led claims against token issuers.

The suit against CashBet, if successful, could enable the plaintiffs to rescind their purchase and receive interest and (possibly) damages as a remedy.

And if successful, it will likely serve as a model for other cases – although given that the statute of limitations for rescission is just one year, investors may need to get their skates on.

Perhaps more ominously for non-compliant token issuers, this may be viewed as a test case for a class action.

As for secondary token holders… they will likely find disappointment down this road; our current understanding is that only the original token holder will be able to bring an action under the rules above.

The case before the California District Court is Nirvana Capital Limited et al v. Mobile Gaming Technologies, Inc. et al, case number 4:18-cv-07483-KAW, retrieved from Pacer on 12/15/2018

*Page 7, Exhibit E of complaint – investor deck allegedly presented by CashBet.

**(The contract in this instance was labeled a Token Purchase Agreement, but they are functionally similar.)

The author is invested in digital assets.