Partner Nicola McKinney discusses crypto, fraud and investor lawsuits in Solicitors Journal



January 16, 2024

With Mercedes F1 facing a lawsuit for having ‘aided and abetted’ fraud at FTX, Partner Nicola McKinney explores the trend for seeking recovery of crypto investment losses from promoters.

 

Nicola’s article was published in Solicitors Journal, 16 January 2024, and can be found here.

Three lawsuits filed at Florida’s Southern District Court in late November 2023 are the latest in a series of legal claims brought by investors looking for ways to recover losses arising out of failed crypto investments.  The federal group actions are brought against high-profile promotors of crypto assets, including the Mercedes Formula 1 Team.

In early November 2023 Sam Bankman-Fried, co-founder and former CEO of FTX, was found guilty on eight charges of fraud and money laundering offences, following a federal trial in New York.  Several other key members of the FTX management team had previously pleaded guilty to various offences and gave evidence against Bankman-Fried.

Earlier in the year FTX investors sued celebrities such as NFL footballer Tom Brady, model Gisele Bundchen and comedian Larry David, who had been closely linked with promotions of the collapsed crypto exchange.

The latest investor-claimants allege that the Mercedes Formula 1 team ‘aided and abetted’ fraud at FTX through its high-profile endorsements and promotions of FTX, the products of a lucrative sponsorship deal.  By featuring FTX’s logo in highly visible placements, such as on its cars and social media feeds, investors allege that the team was a “necessary player” in the fraud.

Further class action lawsuits were filed against Major League Baseball, also by investors on the basis of its sponsorship and promotion of FTX facilitating fraud, and against footballer Cristiano Ronaldo by Binance investors for $1 billion of losses they allegedly suffered through his promotion and association of the company’s products. In 2022 Binance announced a partnership with Ronaldo in collectible NFTs, the value of which dropped significantly after the initial sale values.

While crypto assets have attracted minimal tailored regulation in the US, at the heart of these lawsuits is the contention by the Securities and Exchange Commission (SEC) that crypto assets should be considered as securities, and thereby be subject to existing rules relating to securities, such as a requirement that celebrity endorsers reveal how much they have been paid to promote products or services.

In 2023, there has been a flurry of criminal prosecutions in the US against crypto exchanges and connected individuals, led by the SEC’s Gary Gensler taking a bullish approach. The conviction of FTX’s Bankman-Fried on eight fraud charges is the most high-profile of these. There have also been a number of criminal charges filed against celebrities such as Lindsay Lohan for promotion-related offences.

However, criminal convictions will not normally directly assist investors to recoup their losses.   Investors globally have, therefore, continued to look for effective and inventive routes to recovery where they have lost money through crypto investment, whether through fraud or crashes in the value of their crypto investment.

Throughout 2022 and 2023, the UK courts saw numerous actions to recover losses suffered through crypto fraud.  These were often applications for the disclosure of information from third parties such as crypto exchanges, underpinned by substantive claims against unidentified fraudsters (identified as carefully described ‘Persons Unknown’). However, with the cost of full-blown High Court litigation over months or years often being disproportionate to the sums lost, it appears that few of those claims have been scheduled for trial, and that where claimants have successful recovered some of their losses this has been through the strategic use of information obtained during the applications process.

It will be worth watching whether crypto-related litigation in the UK in 2024 begins to mirror the US trend towards pursuing promotors and marketers.  At the start of October 2023, UK regulation of crypto promotions changed, with the majority of regulatory responsibility in that sector shifting away from the Advertising Standards Authority, and to the Financial Conduct Authority (FCA), taking over the regulation of ads for certain cryptoassets, including cryptocurrencies.

The FCA rules apply to all firms that market qualifying cryptoassets to UK consumers, including firms not based in the UK where UK-based consumers may be affected.  The approach to these marketing rules takes the same forms as existing (and planned) crypto regulation, in that crypto assets themselves are not regulated; instead, specific services and activities – in this case marketing– are governed by rules. The new rules have toughened up and clarified how investments in crypto assets can be promoted, with corresponding enforcement powers where an authorised person breaches the rules, and – importantly for individual investors – corresponding rights for “a private person who suffers loss as a result of the contravention” to bring a direct action for damages.

Under the new FCA regime – which is incorporated into the existing framework regulating activities such as advising in investments – mass marketing of cryptoassets to UK consumers is permitted, provided that the restrictions are not breached, and that foundational requirements like fairness, clarity and not being misleading, are met. The restrictions include requirements for risk warnings, and outright prohibitions on certain incentive schemes, such as offering cryptocurrency as part of a ‘new joiner’ bonus.

There are limits to the new FCA regime however, which does not include cryptoassets that are not directly transferable, such as NFTs, the promotion of which continues to be regulated by the ASA’s CAP Code.  The Code also continues to apply to ‘non-technical’ aspects of promotions, that don’t relate to the technological characteristics of crypto products, but relate for example to advertisements causing offence, fear or distress.

Additionally, there is unlikely to be a surge of investor claims in the UK similar to the recent actions against FTX, as the regulations apply to registered firms, which are likely to exercise caution when promoting crypto assets.  Promotions and endorsements by unregistered firms are likely to attract regulatory and criminal sanction, without free-standing investor rights to sue unless there are other qualifying criteria, for example if (in certain circumstances) there is a contractual relationship.

Litigation in relation to failed crypto investments will therefore probably follow a different course in the UK than is currently seen in the US. The new FCA regulations sit alongside existing, limited regulation of aimed at players in the crypto asset industry, including the requirement for exchange providers to register in accordance with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.

Other regulations which may lead to litigation in the UK courts by crypto investors include breaches of the general prohibition in the Financial Services and Markets Act 2000, if a person carries on regulated activities without authorisation.  A breach would likely amount to a criminal offence and to contracts with investors being unenforceable (subject, for example, to effective arbitration clauses), and with those investors potentially having a right to recover any sums transferred pursuant to the unenforceable contract.

The case of Chechetkin v Payward, brought by an investor against the UK arm of the Kraken exchange, and where the investor has already resisted an arbitral award in related proceedings, will in 2024 probably see the first trial for this kind of claim.