Southern District Of Florida Dismisses Claims Against Individual Defendants Related To Initial Coin Offering For Failure To Adequately Allege “Seller” Status Or Reliance

Shearman & Sterling LLP

Shearman & Sterling LLP

On May 13, 2019, Judge Robert N. Scola, Jr., of the United States District Court for the Southern District of Florida dismissed all claims asserted against four individual defendants under Sections 12(a)(1) of the Securities Act of 1933 (the “Securities Act”) and Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) in an action against the cryptocurrency company Centra Tech, Inc. and certain of its officers and celebrity promoters.  Rensel v. Centra Tech, Inc., et al., No. 17-24500-Civ-Scola (S.D. Fla. May 13, 2019).  Plaintiffs alleged that the company made a series of misrepresentations while marketing an initial coin offering, and that the individual defendants were responsible as “sellers,” because they encouraged the purchase of unregistered securities.  Addressing the individual defendants’ motions to dismiss, the Court dismissed plaintiffs’ Securities Act claims for failure to adequately allege that the individual defendants were “sellers” within the meaning of the Securities Act and dismissed plaintiffs’ Exchange Act claims for failure to adequately allege reliance.

Plaintiffs alleged that the company purported to sell “CTR tokens” in an initial coin offering (“ICO”) to raise funds for a debit card backed by Visa and MasterCard that would allow users to access various cryptocurrencies to make purchases.  Drawing on allegations from an SEC enforcement action and criminal charges against the company’s founders, plaintiffs alleged that the company made a series of misrepresentations relating to its product and the company’s relationship with credit card companies, as well as creating fictional executives with impressive credentials.  Slip op. at 2.  With respect to the individual defendants, plaintiffs alleged that the two officers were personally familiar with the content of the website used to promote the company or answered investor questions about the company in online forums.  Plaintiffs alleged the two celebrity promoters used social media channels to promote the ICO.  Id.

Plaintiffs asserted that the individual defendants violated Section 12(a)(1) of the Securities Act because they were “sellers” of unregistered securities.  As stated by the Court, to be deemed a “seller,” the defendant must either “(1) be the person who transfers title to, or other interest in, that property or (2) successfully solicits the purchase, motivated at least in part[] by a desire to serve his own financial interest or those of the securities owner.”  Id. at 4.  The Court held that, even to the extent the individual defendants were considered to have solicited plaintiffs’ purchases, plaintiffs failed to establish that they were “sellers” within the meaning of the statute because a causal relationship needed to be shown between the allegedly solicitous action and the purchase of securities.  Id. at 5-6. 

Indeed, the Court emphasized that the Eleventh Circuit requires that a defendant “actively solicited investors” and “the plaintiff purchased securities as a result of that solicitation.”  Id. at 5.  Because there were no non-conclusory allegations that plaintiffs purchased as a result of the individual defendants’ solicitation, the Court dismissed these Securities Act claims.  See id. at 6.  In particular, the Court held that, even if the celebrity promoters’ social media posts showing themselves using a Centra Tech debit card could be considered solicitations, there was no allegation that such solicitation was successful, or indeed any allegation that any plaintiff had a relationship with defendants or even followed their social media accounts.  See id. at 5-6.  The Court also emphasized that maintaining the company’s website, or responding to questions in an online forum, fell short of establishing that defendants successfully solicited the purchase of CTR tokens directly from any particular plaintiff.  Id. at 9, 11.

Plaintiffs’ inability to plead a causal relationship between the alleged misrepresentations and any actual token purchases also resulted in the Court’s holding that they could not plead the reliance element necessary to state a claim under Section 10(b) of the Exchange Act.  Plaintiffs attempted to overcome that shortcoming by invoking the “fraud-created-the-market” presumption of reliance, which provides that reliance may be presumed in certain egregious cases because “it is reasonable to rely on the market to screen out securities that are so tainted by fraud as to be totally unmarketable.”  Id. at 7.  However, the Court held that plaintiffs failed to demonstrate that, but for defendants’ alleged conduct, the CTR tokens could not have been marketed.  Indeed, the Court emphasized that the CTR tokens were selling before the celebrity promoter defendants became involved.  See id. at 8.  With respect to the two officer defendants, the Court held that there was no allegation that, but for posting in online investor forums, the CTR tokens could not have been offered in the market.  Id. at 11.  Moreover, while the company’s website “may have helped convince customers that [the company] was a legitimate business,” id. at 9, plaintiffs failed to make any allegations with specificity as to “the content of the website, when the website was launched, the alleged misstatements on the website, who determined the content on the website, and if the Plaintiffs ever even visited the website.”  Id. at 10.  Thus, the Court dismissed the Exchange Act claims for failure to plead reliance.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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