Got the Suitcase up in the Centra Part II

Florida Court holds Centra ICO Tokens to be Securities

As a follow-up to a previous blog and podcast, one of my clients sent me this article about Centra’s class action litigation. Apparently, we have the first ever Security classification in the cryptoverse.

Centra Tech Inc. (“Centra”) did their ICO from July 30, 2017 through October 5, 2017 and raised over USD $30 million. Their product — the Centra Debit Card — was a fraud. The two co-founders were arrested on April 1, 2018, one of them was found at the airport trying to flee the country when the Dept. of Justice tracked him down. See SEC Press Release: https://www.sec.gov/news/press-release/2018-53

On June 25, 2018, Judge Andrea Simonton issued a report and recommendation finding that the Centra Tokens (“CTR”) were in fact sold as investment contracts (securities). See https://www.scribd.com/document/382734281/Centra-6-25

The 19-page report highlights are as follows: “It is RECOMMENDED that Plaintiff’s Renewed Motion be GRANTED to the limited extent consented to by the Defendants; and otherwise, DENIED.

Class Action Plaintiffs (main) arguments were:

(1) Temporary Restraining Order (“TRO”) to prevent any Centra affiliates from transferring the ICO proceeds;

(2) An asset freeze on Defendants: Centra Tech, Sharma, Trapani, Farkas, and Hagner — along with Centra Tech’s current or former officers, agents, affiliates and individual defendants’ affiliates, representatives and other relevant individuals’ accounts and/or digital currency wallets holding any ico proceeds. (Mayweather/DJ Khalid?????)

(3) Defendants and affiliates keep all evidence in tact.

(4) Defendants and affiliates provide the Court a detailed Accounting of their transactions pertaining to the Centra ICO proceeds (all transfers, liquidations, purchases, and expenditures — aka Lambo garage & yacht dock receipts).

On April 13, 2018, the criminal case in the Southern District of New York (“SDNY”) issued a warrant to seize 91,000 Ethereum (“Eth”) stored in the main ICO wallet. Today, the government has that money.

The TRO Standard:

In order to win a Temporary Restraining Order motion, you have to prove ALL of the following: (Injunctions are considered very drastic)

(1) Substantial likelihood of success on the merits of the underlying case;

(2) The movant will suffer irreparable harm in the absence of an injunction;

(3) The harm suffered by the movant in the absence of an injunction would exceed the harm suffered by the opposing party;

(4) An injunction would not disserve the public interest.

Centra responded by agreeing to restrain from accessing the proceeds of the wallet (which was already seized by the government based on the criminal proceedings in SDNY). They also consented to freezing another wallet that contained 8,932 Eth.

Centra Tokens as Securities

The Defendants conceded that the Centra tokens sold are securities. They noted an intention to challenge that classification later, if necessary. The Judge still analyzed the Tokens using Florida law (notably, the Howey Test came from Florida) to define and interpret the 1933 Securities Act definition of an Investment Contract. “An offering is an investment contract if there is: (1) an investment of money (2) in a common enterprise, (3) with the expectation of profits to come solely from the efforts of others.” Tippens v. Round Island Plantation LLC, 2009 WL 2365347, at *9 (S.D. Fla. July 31, 2009) (citing SEC v. Unique Fin. Concepts, Inc., 196 F.3d 1195, 1199 (11th Cir. 1999).

Prong 1: The Judge said that the investment of Eth and Bitcoin satisfy the first prong.

Prong 2: In the Common enterprise analysis, the Judge quoted SEC v. Unique, 196 F.3d at 1199 (citing Villeneuve v. Advanced Bus. Concepts Corp., 698 F.2d 1121, 1124 (11th Cir. 1990)) (“a common enterprise exists where the ‘fortunes of the investor are interwoven with and dependent upon the efforts and success of those seeking the investment of third parties.”). “The thrust of the common enterprise test is that the investors have no desire to perform the chores necessary for a return, and are attracted to the investment solely by the prospects of a return. Eberhardt v. Waters, 901 F.2d 1578, 1580–81 (11th Cir. 1990). She decided Centra was a common enterprise because an individual investor had no control over the success or failure of his or her investment.

Prong 3: Florida’s case law specifies the third prong requires: “the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.’” Bamert v. Pulte Home Corp., 445 Fed. App’x 256, 262 (11th Cir. 2011) (quoting Williamson v. Tucker, 645 F.2d 404, 418 (11th Cir. 1981)); see also SEC v. Merchant Capital, LLC, 483 F.3d 747, 755 (11th Cir. 2007) (“‘the focus is on the dependency of the investor on the entrepreneurial or managerial skills of a promoter or other party’”) (quoting Gordon v. Terry, 684 F.2d 736, 741 (11th Cir. 1982)). Since the success of Centra Tech depended on the Defendant’s work, this third and final prong was satisfied.

We have a Security!

No registration statement was filed with the SEC, Defendants used the instrumentalities of interstate commerce to sell their ICO. (This requirement is so broad, it can probably be satisfied by sending out a sales-tweet originating in one state, and read by a potential investor in another state.)

The Defenses Raised by Centra:

While Centra has not yet filed their answer, they allege that the Lead Plaintiff did not suffer any loss — He bought his Centra ICO Tokens for 16.1 ETH ($3,250) and sold for 0.709 BTC ($3,517).

The other Lead Plaintiff, Mr. He, suffered $206,483 loss. Defendants argued for arbitration, but were unable to produce any documents that would bind plaintiffs to an arbitration.

The Injunction/TRO

The judge found the Plaintiffs failed to prove a likelihood of actual and imminent irreparable injury, finding injunctive relief improper. However, the Defendants have agreed to certain precautionary injunctive relief.

Conclusion

Notice the major typo. It says that “Defendant’s Renewed motion…” This was the Plaintiff’s Motion. Regardless, the Defendants assets held in their two known ICO wallets are currently frozen. Centra Tech, Inc., Sharma, Trapani, Farkas, Hagner, and other officers agents, employees, and/or rep’s of Centra Tech, or heir of Hagner (Hagener is dead), are enjoined from:

Accessing the assets in the ICO wallet for any purpose other than complying with a valid court order; and

Destroying, erasing or otherwise making unavailable for further proceedings in this matter, any records or documents, books, records, accounts, account passwords, computer passwords, device PINS and passwords, cryptographic keys, or any instruments, data, and papers relating in any manner to the ICO

Defendants have 14 days to file written objections, then Plaintiffs have another 7 days to object to the objections. Failure to object waives the right to challenge on an appeal.

The Implications:

Since this was made in the context of a TRO, and not in a trial, this report is only dicta, not binding precedent. However, the analysis can certainly be used as a roadmap for future litigation. The presence of the fraud in this case make it easier for a judge to come down on the side of the ICO being a security, but there are still many nuances that must be understood before classifying every ICO into this bucket. Bad facts often makes for bad law.