Blockchain Blog

Tezos Faces Legal Action

By Marina Fyrigou-Koulouri, Alexandra Levin Kramer and Michael Maloney

Tezos, the blockchain startup that raised $230 million in July 2017 in the largest initial token offering (“ICO”) until then, is now facing a class action complaint in the California Superior Court in San Francisco.

The complaint, filed on October 25, 2017, was brought as a class action against Kathleen and Arthur Breitman and their company Dynamic Ledger Solutions, the Tezos Foundation and its president Johann Gevers and Strange Brew Strategies, LLC (collectively, “Defendants”).  The purported class representative (“Plaintiff”) alleges that the Tezos sale of “XTZ” tokens or “Tezzies”, constituted the sale of unregistered securities in violation of regulations of the U.S. Securities and Exchange Commission (the “SEC”). According to the complaint, “Defendants did not register these Tezzies with the SEC, and many of the representations defendants made regarding the status of the Tezos project in the run-up to the ICO were either exaggerations or outright lies.”[1] In addition, the complaint further claims that Defendants made false statements and representations concerning the ICO, which violate false advertising and unfair competition laws. 

This lawsuit was filed after infighting among Tezos principals, Arthur and Kathleen Breitman, and other problems within Tezos, recently came to light. Arthur and Kathleen Breitman admitted that the “progress…has fallen short of [their] expectations.”[2] According to the company, the Tezos network will not be available by December 2017 at the latest, as originally stated, and its “current best estimate for shipping the main net is now February of 2018, though the firm date remains ‘when it’s ready.’”[3]

In support of the claims for violations of securities laws, the complaint refers to an SEC report[4] which states that some ICOs are in fact offerings of securities and therefore need to comply with the U.S. securities laws. The referenced report discusses the question of whether ICOs represent a “non-refundable donation” versus “speculative investment.” According to Plaintiff, while the Tezos ICO’s “purported terms” described the purchase of Tezzies as a non-refundable donation, he “was not shown these terms at any stage during the ICO process, nor did he agree to them.”[5] On the contrary, Plaintiff alleges that Defendants led him to believe that it was an investment.

The complaint seeks certification of a class comprising of “[a]ll natural persons who purchased Tezzies during the ICO conducted by Defendants in July 2017…”  Plaintiff alleges that the class is estimated to include approximately 30,000 people who purchased Tezzies. The complaint demands rescission of the purchase of Tezzies as well as other damages.

It appears that the Breitmans have made statements that the complaint is meritless but otherwise have not yet responded. 

Before looking at the merits of the case, though, the court will have to determine whether it has jurisdiction to hear the case. Indeed, Tezos, like many other U.S. crypto firms, established a Swiss foundation aiming, inter alia, to avoid liability in the United States. Funds were raised by the Swiss foundation, which would buy the technology and distribute the tokens. In addition, Tezos employed provisions “bar[ring] class or collective proceedings and requir[ing] claims to be brought in an ordinary court in Zug, Switzerland.”[6] Therefore, the primary issue is how will the court treat the ICO’s terms and conditions. If the terms are enforced against Plaintiff, the suit will be dismissed. Investors would have the right to sue Tezos individually, not through class proceedings, only in Zug.

However, the treatment of tokens by the SEC is crucial here too. If they are considered securities, failure to comply with U.S. securities registration and disclosures requirements may lead to civil and criminal sanctions against both U.S. and non-U.S. entities, as was possible in the DAO case[7]. The Swiss foundation model does not seem to be an effective shield against liability. 

It should be noted that on November 13, 2017, a second class action[8] was filed against Tezos in the Federal District Court in Florida.

This lawsuit also alleges that Tezos’s ICO violated U.S. securities law and that Defendants’ fraudulent statements and false representations misled investors. Plaintiff claims that the ICO's terms constitute a contract between the parties and accordingly, it demands the rescission of the contract.

 



[3] Id.

[5] Supra note 1.