02 May 2018

So what if my digital token is a security? Personal liability in claims made for rescission damages

Earlier this year, Brad Jacobsen, partner at MSI's Utah law member Michael Best & Friedrich LLP, posted a blog titled “Whether You Are Raising Capital for Bitcoins or Beavers, Securities Laws Will Apply.” The most common response we hear is “So What?!” In this article, Brad Jacobsen focuses on one of the most commonly used civil claims by plaintiffs’ counsel to obtain monetary damages in connection with securities offerings: A claim for Rescission.

A fair question, no doubt. The brief answer is that failure to comply with applicable state and federal securities laws can result in significant personal liability (civil and criminal). For this post, I will focus on one of the most commonly used civil claims by plaintiffs’ counsel to obtain monetary damages in connection with securities offerings: A claim for Rescission. A claim for rescission is essentially seeking to unwind the investment transaction where there was a violation of securities laws. Typical violations include:

Failure to register a security;
Failure to properly qualify for an exemption from registration of a security;
Using a “finder” or otherwise paying an improperly licensed party a fee in connection with the capital raise; and/or
Failure to properly disclose all material information needed for the investors to make an informed investment decision.

In a situation where a company is looking back in time at a previously closed initial coin offering (ICO) or other digital token sale where such sales were done without complying with applicable securities laws (but in retrospect the investment met the “Howey Test” described in my prior post), the violation of securities laws is essentially a given. In such a case, all investors may seek rescission damages from those who participated in the issuance and sale of the security (i.e., ICO or other blockchain (mostly digital tokens)). In almost all states, like Utah, not just the company issuing a security is liable to the investors that have a claim for rescission. Additional parties that can be “jointly and severally” liable (i.e. liable for the full amount) with the issuing company are “every person who directly or indirectly controls a seller.., every partner, officer, or director of such a seller or buyer, every person occupying a similar status or performing similar functions, every employee of such a seller … who materially aids in the sale …with and to the same extent as the seller….” Essentially, everyone involved! Note that by statute the employees/officers/directors and other involved parties are individually liable for rescission damages – the “corporate veil” does not need to be pierced as the statue pierces it for the plaintiff. Rescission Damages: Rescission seeks to put the party who was harmed in the same position as though he/she had not made the investment in the first place. Almost every state has a recession statute that provides for the calculation of rescission damages. In Utah, for example, rescission damages equal:

The amount invested; plus
12% per annum in interest since the date of investment; plus
Legal fees – minus
Any distributions already made on the investment; and
When it can be shown that the applicable violation was reckless or intentional, treble (3X) damages can be awarded.

So What now? Every person involved in the issuance and sale of an ICO/ blockchain/ Cryptocurrency should make sure that legal counsel has been obtained as to whether or not securities laws apply. When people lose money, plaintiffs’ counsel will not be far behind. Since Rescission Damages include the reimbursement of legal fees, the amount of damages isn’t what is important to plaintiffs’ counsel, only the amount of money that the defendants collectively have. Plus, with the potential claim for treble (3X) damages, investors and plaintiffs’ counsel have additional incentive to seek damages. On the flip side, if you have lost money in an investment in ICO/blockchain/ Cryptocurrency, you may be entitled to seek Rescission Damages yourself and should consult with an experience securities attorney. It should be noted that if a company comes to the conclusion that it may have violated securities laws already, it can conduct a “Rescission Offer” on its own accord. In a rescission offer, an issuer offers the investors their money back plus the applicable state statutory rate. If an issuer initiates such an offer before it is sued for Rescission Damages, it can avoid a civil lawsuit against it and its officers/directors/employees in the future. A rescission offer is, in itself, a securities offering and legal counsel should be consulted. Michael Best has an integrated team that works with clients in the cryptocurrency, ICO, and blockchain space. We assist in securities, investment, Bitcoin and other cryptocurrencies, intellectual property, privacy and security, blockchain implementation, and other matters in this space.

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