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Giga Watt ICO Faces Tezos-like Securities Litigation Challenge

Giga Watt, Inc. and a related entity got a late Christmas present on December 28: a lawsuit alleging that Giga Watt violated federal securities laws in its initial coin offering (“ICO”). The plaintiff seeks more than $5,000,000.

Giga Watt ran its ICO to support a full-service, turnkey processing center offering a “full range of mining services from hosting, maintenance, and repair to private blockchain servicing” (the “Project”). During the period of the ICO, investors could invest Bitcoin, Ether, or "fiat" currency (government-backed money) in exchange for either: (a) Giga Watt tokens (“WTT”) that offered 50-year mining privileges, or (b) actual mining equipment and related power supplies. The Project is said to still be in development, but the plaintiff alleges it may never finish.

The plaintiff became concerned when Giga Watt announced that his group's batch of tokens was going to be delayed. Giga Watt refused to give a refund. The Complaint alleges that, instead of keeping the invested funds in escrow as promised, all of the cryptocurrency funds raised from investors in the ICO have been converted to cash, released from escrow, and put into a Giga Watt operating account.

Those following cryptocurrency legal developments will not miss the similarities to the Tezos lawsuits earlier in 2017. But it's worth noting that the Tezos lawsuit involves, in part, California state securities law, including the “Risk Capital Test,” which differs fairly significantly from the Howey test typically discussed in the context of whether a token constitutes a security for federal securities law purposes.

Takeaways and Questions

1.  Expect cryptocurrency companies to begin utilizing class action waivers.

Two significant class action lawsuits have now been filed against cryptocurrency companies. Since class actions can accumulate large damage claims against companies, we might expect to see cryptocurrency companies try to mitigate this risk by including contractual class action waivers in their contracts, terms & conditions, and offering materials (though enforceability in an ICO would be a new question).

2.  Is the WTT “utility” token a “security” for federal securities law purpose?

The WTT token seems to be what is commonly referred to as a “utility” token, which some commentators and cryptocurrency companies believe is an asset, rather than a security. SEC Chairman, Jay Clayton, has stated that the key hallmarks of a securities offering are when “prospective purchasers are being sold on the potential for tokens to increase in value—with the ability to lock in those increases by reselling the tokens on a secondary market—or to otherwise profit from the tokens based on the efforts of others.” The Giga Watt Complaint alleges that representatives of Giga Watt touted the potential for an increase in value of WTT, and that the investment was made before the batches were complete, meaning the WTT had no utility at the time of the investment. Whether the token is a security is very much in dispute.

3.  Consider legal disclaimers in ICO documents.

In both the Tezos and Giga Watt cases, the plaintiffs described communications from management touting the potential for future profits by investing in the tokens, and a specific timeline for completion of projects or performing certain actions. Typically, offering documents in securities transactions will include legal disclaimers that these types of claims are forward-looking and may not actually occur.  Some companies conducting token offerings have decided to exclude these standard legal disclaimers from their white papers and other documents, perhaps thinking that it would be best to avoid legal language that is typically associated with an offering of securities. However, the plaintiff in the Giga Watt case used the absence of such legal disclaimers to bolster its securities fraud claim.

4.  How will damages be calculated with losses of Bitcoin, Ether and other cryptocurrencies?

Due to the volatility of the cryptocurrency markets, an issue is created when a purchaser of tokens uses other cryptocurrencies (such as Bitcoin or Ether) as payment. In the Giga Watt case, the plaintiff alleges damages in an amount equal to the value of the invested Bitcoin and Ether as of the time of the filing of the Complaint (the price of Bitcoin and Ether rose substantially from the time it was originally invested up to the time of the filing of the Complaint). However, Giga Watt immediately converted the Bitcoin and Ether to cash once received. So what is the amount of damages in this scenario? This is likely to be the subject of both legal and expert debate.

KMK Legal Alerts and Blog Posts are intended to bring attention to developments in the law and are not intended as legal advice for any particular client or any particular situation. Please consult with counsel of your choice regarding any specific questions you may have.

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