District Of Connecticut Certifies Class In Cryptocurrency Mining Suit, Holding That Proposed Class Could Establish Reliance Based On Common Proof
On June 21, 2019, Judge Michael P. Shea of the United States District Court for the District of Connecticut granted plaintiffs’ motion to certify a class of investors in an action alleging that two cryptocurrency companies falsely represented that they were using investors’ money to mine for cryptocurrency when, in fact, they were engaged in a Ponzi scheme. Plaintiffs asserted claims against the companies and their owners under Section 10(b) of the Securities Exchange Act of 1934, Connecticut securities law, and for common law fraud. Audet v. Fraser, No. 3:16-CV-0940 (MPS), 2019 WL 2562628 (D. Conn. June 21, 2019). The Court held that each of the requirements for class certification was satisfied and, in particular, that even though no presumption of reliance was available, reliance on misrepresentations could be established on a class-wide basis based on common proof.
Plaintiffs alleged that defendants offered various services pursuant to which investors’ money was to be invested in cryptocurrency mining equipment, with certain proceeds of the mining to be returned to the investors. Id. at *2. In reality, defendants allegedly did not have the mining equipment they represented and were instead creating an artificial return by using money from new investors to pay earlier investors. See id. at *3-4. Ultimately, the SEC began investigating the companies and their founder and CEO. That founder pleaded guilty to criminal charges and admitted that he operated a Ponzi scheme. Id. at *4. Investors then brought suit against the companies and another owner of the company, who was the only active defendant after the companies themselves failed to appear. Id. at *1 & n.1.
The Court first determined that the proposed class (with modifications) satisfied Article III’s standing requirements. It rejected defendant’s argument that the class must exclude those who “broke even or profited” from their investment, and concluded instead that a plaintiff suffers an injury when she “changes her position—such as by buying or selling—as a result of a material misrepresentation.” Id. at *6-7. The Court also held that individuals who “mined” for a cryptocurrency product, or converted one such product into another, met Section 10(b)’s requirement of a “purchase” or “sale” of securities. Id. at *8.
Turning to the class certification requirements of Rule 23(a), the Court determined that both typicality and adequacy were satisfied. The Court held that differences in the manner in which plaintiffs and other members of the putative class acquired cryptocurrency were irrelevant because they had relied on the same misrepresentations as the rest of the class. Id. at *10. Moreover, the Court rejected arguments that certain named plaintiffs were subject to unique defenses, including with respect to their own alleged bad acts and access to nonpublic information because (i) defendant had not identified evidence suggesting that named plaintiffs were aware of the fraud and (ii) access to nonpublic information would not undermine the common claim based on public material misrepresentations. Id. at *11.
The Court further held that, even though the parties agreed that the rebuttable presumptions of reliance set forth in Basic Inc. v. Levinson, 485 U.S. 224 (1988), and Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972), did not apply, individual issues of reliance did not necessarily predominate as a matter of law and, thus, the requirement that common questions predominate over individual ones was satisfied at this stage. 2019 WL 2562628, at *20-21.
First, the Court found that the core alleged misrepresentations could be proved through common evidence, as many such misrepresentations were made “to all prospective purchasers of [the companies’] products—on the Companies’ websites and in statements printed in widely read industry publications like the Wall Street Journal.” Id. at *21. In addition, the Court rejected defendant’s argument that the “mix” of information available to investors, as well as their level of sophistication and due diligence, varied, such that individual analyses would be required to assess the impact of the alleged misrepresentations. Id. at *22. The Court noted that all the alleged misrepresentations consistently suggested that investors would receive payouts based on defendants’ mining activities, and that no level of sophistication could “debunk” certain of the misrepresentations, such as that the companies had agreements with major retailers to accept a new form of cryptocurrency and that the new currency would be backed by a hundred-million-dollar reserve fund. Id. at *22.
Second, the Court agreed with plaintiffs that a reasonable juror could conclude that, absent the misrepresentations, no rational investor would have purchased the companies’ products. Id. at *23. As the Court explained, the products offered were “novel financial investments being sold by a start-up company with no established track record” and it was therefore reasonable to infer that the representations about the nature and potential uses of the products would be relied upon by a reasonable investor, and that no reasonable investor would have knowingly participated in a Ponzi scheme. Id. The Court also rejected defendant’s argument that some investors may have learned of the alleged fraud and posted complaints on social media, supporting the need for an individualized inquiry; the Court noted the lack of evidence in the record about such posts, and found the argument insufficient when weighed against representations made by the companies’ CEO through official channels and major media outlets. Id. at *24. The Court, did, however, end the class period earlier than plaintiffs had proposed, finding that no reasonable investor would have purchased products offered by defendants once media reports emerged regarding various misrepresentations. Id.
The Court also held that individual issues of loss causation did not threaten to predominate over common issues and that defendant’s arguments largely overlapped with and were disposed of by the Court’s discussion of reliance. In any event, the Court held that plaintiffs could show loss causation by proving that the loss was “foreseeable and caused by the materialization of the risk concealed by the fraudulent statement.” The Court noted that plaintiffs could establish on a class-wide basis, for example, that misrepresentations regarding computing power or the existence of a hundred-million-dollar fund backing a new form of cryptocurrency were the proximate cause of the subsequent loss. Id. at *25.