Centra: Contradictory Tokens, Celebrity Endorsements, and a Florida Class Action

Introduction

2017 closed with a flurry of ICO activity, especially on the legal and regulatory side of the table. Throughout Q4, ICO participants filed a slew of class actions against the organizations running those ICOs, and an ICO by restaurant review platform aspirant Munchee even triggered an SEC Cease and Desist. 

This post spotlights Centra, a Miami startup that promised to build a crypto debit card platform, and its $30 million ICO, questionable credit card company relationships, A-list entertainment proponents, and alleged securities law violations.

Facts

At the time of its ICO, Centra planned to develop a cryptocurrency-focused debit and credit card system that would allow users to spend bitcoin, for example, anywhere that accepted certain major cards. Through the Summer and Fall of 2017, Centra publicized relationships with Visa and Mastercard, leverageable towards facilitating instant crypto-transactions. Centra also published its intentions to create an online crypto marketplace (“cBay”) and Centra-centric blockchain. The startup generated hype for its ICO via celebrity endorsements. In mid-September, boxing champ Floyd Mayweather encouraged his 8 million Twitter followers to “Get yours before they sell out,” referring to Centra’s CTR tokens. Rapper DJ Khaled trumpeted Centra across social media platforms as well. Seemingly overnight, millions knew of Centra, and the startup raised between $30 and $50 million by October 2017.

A Florida Class Action

On December 13, 2017 a Centra ICO participant filed a class action complaint on behalf of fellow Centra ICO participants in the US District Court of Southern Florida, alleging that the Centra ICO was a securities sale illegally unregistered with the SEC. Rensel v. Centra Tech, Inc., 1:17-cv-24500-JLK (“Rensel”). Via this ICO, Centra orchestrated “a flimsy façade” claiming that its tokens were not securities but rather “utility tokens” over which the SEC had no jurisdiction, complains Rensel. Id. at 13.

Rensel also takes aim at the allegedly deceptive nature of Centra’s Mastercard and Visa engagements, Id. at 3, and even its celebrity endorsements. Id. at 13.

Utility Tokens versus Securities

Rensel alleges that Centra dubbed its CTR tokens as “utility tokens”—not because this term accurately described CTR, but because the startup believed this tag alone would shield Centra from SEC jurisdiction. Id. at 14. Centra made contemporaneous, conflicting statements to this effect concerning their offering, asserts Rensel, including:

-          That each CTR was a “utility token” that “will surge in value,” in an online post, Id. at 15;

-          That ICO participants would be able to either use their CTR “or trade them on cryptocurrency exchanges for a profit,” per Centra’s white paper, Id. at 18; and

-          That Centra's ICO participants were “investors,” stated repeatedly, Id. at 2.

These statements—and a multitude of others made on podcasts and online—sent contradictory signals to participants as well as regulators, per Rensel.  A (non-SEC regulated) utility token’s function is to provide a utility, i.e. access or future access to a product or service, not to passively rise in value on the efforts of the offeror, which is the function of a (regulated) security. Centra sought to straddle the line between securities and utility tokens, in effect marketing both ways on a one-way street, in increasing regulatory traffic.  And ended up, according to Rensel, simply offering an unregulated, and therefore illegal, security.

Red Flags – Visa and Mastercard

Rensel isn’t the first to raise red flags around Centra. In October, a New York Times investigation revealed substantial inconsistencies concerning Centra’s touted connection to Visa and Mastercard. These relationships, pivotal to Centra’s pitch towards developing a crypto-credit and -debit system, turned out to be nascent at best, and outright nonexistent at worst.

Centra’s proposed debit and credit capability hinged on its claimed connection with established credit card companies. So, Visa once featured heavily on Centra’s website. The site even displayed mockups of crypto credit cards stamped with the Visa logo. But when the Times asked Visa about the nature of its connection with the exciting new crypto startup, Visa responded that it had never approved Centra to work with the Visa network. In fact, said a Visa spokesperson, Centra never even applied to Visa for this capability.

After the Times contacted Visa, Centra erased Visa’s logos and mentions from the Centra website. Soon after that, per the Times, a Centra founder said in an interview that Centra had refocused on the Mastercard network, which Centra would employ instead of Visa. But, yet again, when the Times reached out to Mastercard, this credit card company also denied any ties to Centra. Rensel folded much of this allegedly deceptive narrative, as well as other press releases and interviews in which Centra claimed relationships with both Visa and Mastercard, into its complaint. Rensel, at 10-15.

As of now, Visa is not mentioned on the Centra website. However, while Centra’s credit card mockups show only the Centra “C,” Centra's white paper still asserts that its "customers can use Centra Card anywhere in the world that accepts Mastercard."

Red Flags – Celebrity Endorsements

The Times also reported certain oddities regarding Centra’s celebrity endorsements. And Rensel, citing the Times, alleges that the defendants paid—in cash—for the high-profile Mayweather and Khaled endorsements, then claimed "partnerships" with the entertainers. Rensel, at 13. Mayweather’s spokesperson, for one, told the Times the boxer was “not involved in any continuing relationship with Centra.” Id.

Although Rensel clarifies that alleged deceptions such as these are not determinative of Rensel’s claims—since “Defendants are strictly liable for the offering and selling of unregistered securities in connection with the Centra ICO,” Id. at 3—these surrounding deceptions are presented rather “to stress the need for judicial immediate intervention given Defendants’ clear manipulation of investors.” Id. at 13.

On December 15, Centra's blog published the company's refutation of Rensel, calling the plaintiff an "alleged purchaser of Centra Tokens" whose suit "attempts to mimic claims and allegations the Securities and Exchange Commission has lodged against other cryptocurrency offerors." 

Conclusion

Centra exhibited other red flags, from a founder’s spotty criminal history to a crew of nonexistent employees—including an executive who apparently existed only on LinkedIn (more on these in the Times).

Yet Centra still lives. In a press release published January 14, Centra announced a revamped executive roster including a new CEO, COO, and CIO. The press release highlights the new execs' legal and regulatory experience, in particular, and mentions that Centra’s new CIO just left Visa, where he served as Senior Information Security and Compliance Officer for Global Service Operations.

Also noted in this press release: Centra just shipped its first batch of Centra Cards. But this time, Centra refers to its card recipients not as “investors,” but as “contributors.”

ICO December in Review: Munchee, the SEC, and a Centra/ATB Tease

December was a great month for ICO guidance. 

On December 11, the Securities and Exchange Commission (“SEC”), the U.S. federal agency at the forefront of ICO regulatory developments, published its Cease and Desist Order against Munchee Inc., purveyors of an iPhone restaurant review app with a $15 million ICO, for selling unregistered securities in violation of Sections 5(a) and 5(c) of the Securities Act of 1933 (“Securities Act”). On December 13, ICO participants in Centra, a crypto-debit card company with proponents like Floyd Mayweather and DJ Khaled, filed a class action U.S. District Court of Southern Florida alleging Centra committed the very same SEC violations via its $30 million coin offering. And on December 21, ATB, fielded a like-minded class action complaint in the Southern District of New York for its blockchain-based payment system and estimated $24 million ICO. All of this on top of the recent—and compounding—Tezos litigation marks an eventful month for the intersection between ICOs and their regulatory bodies.

This post analyzes the Munchee story; the next will tackle Centra, then ATB.

Munchee

In reaching its conclusion that Munchee violated the Securities Act, the SEC applied the “Howey Test,” the most common test for determining whether ICO tokens, for example, are investment contracts. The Howey Test stems from a seven-decade-old Supreme Court case, SEC v. W. J. Howey Co., 328 U.S. 293 (1946), and its progeny, and essentially analyzes whether a sale involves an:

(1) investment of money (or other consideration)

(2) in a common enterprise, with

(3) profits to come solely or primarily from the efforts of others (i.e. participants in an ICO, for instance, may have a reasonable expectation of profits based on the ICO proprietors’ entrepreneurial or managerial efforts).

Any sale that meets these qualifications—all of them—is a sale of securities. And any offering or sale of securities, per Sections 5(a) and 5(c) of the Securities Act, must be registered with the SEC (or exempted from registration) to be lawfully offered for sale or sold. Following the SEC’s Cease and Desist notice to Munchee, and in anticipation of SEC proceedings, Munchee settled with the SEC, unilaterally terminated every one of its contracts of sale with its ICO participants, and returned all of its $15 million in ICO proceeds.

Since the Howey Test’s applicability to ICOs and the tokens they hock is relative to the sort of token, business, and sale that occurred, SEC guidance on this subject via a third party such as Munchee may be useful to those planning ICOs of their own.

Facts & Passage

Munchee offered and sold “MUN tokens” (Ethereum based crypto coins) in a general solicitation that included potential U.S. investors—and in doing so, met the first two elements of the Howey Test.  In terms of the third element, the SEC asserted that Munchee instilled a reasonable expectation of future profit (based upon Munchee’s future efforts) in its ICO participants.  In the leadup to its ICO, via its white paper and online posts, Munchee publicized that it would:

(a) continuously revise its app;

(b) use the ICO proceeds to create an “ecosystem” of restaurant reviews and shares that would, in turn, increase the value of the MUN tokens; and

(c) foster a secondary trading market for MUN tokens shortly after the completion of the offering and prior to the creation of the ecosystem.

Finally, these efforts were entirely reliant on Munchee (as opposed to the ICO participants) since, at the time of the ICO, “no other person could make changes to the Munchee App or was working to create an ‘ecosystem’ to create demand for MUN tokens,” per the SEC.

So, said the SEC, Munchee passed the third element of the Howey Test, and the Howey Test itself.

Timeline

A primary key to Munchee’s fact pattern and Howey passage was Munchee’s timeline. Munchee sold MUNs before they were fully functional in the way Muchee’s marketing promised, meaning, before the “ecosystem” that the Munchee squad said would stimulate MUNs’ value was operational. This founded the SEC’s argument that MUNs were securities, whose value hinged solely on the future efforts of Munchee and the future profits those efforts may—or may not—yield.

MUNs

Another key: Munchee’s tokens themselves were also problematic. Certain ICOs seek to fail the Howey Test—namely its third, future profit/future effort prong—and avoid the SEC’s regulatory reach by deeming their ICO token a “utility token,” which, they say, provides future access to a platform, or to another service or product. Munchee went this route, going so far as to assert in its white paper that the company conducted a “Howey analysis” and assure readers that “as currently designed, the sale of MUN utility tokens does not pose a significant risk of implicating federal securities laws,” as cited by the SEC. However, the SEC pointed out, Munchee never published this analysis.

Legitimate utility tokens may well be outside the definition of securities, but not all organizations necessarily sell legitimate utility tokens. Take Munchee, for example. Per the SEC, whether MUNs were utility tokens was unclear. First, “[w]hile Munchee told potential purchasers that they would be able to use MUN tokens to buy goods or services in the future after Munchee created an ‘ecosystem,’ no one was able to buy any good or service with MUN throughout the relevant period.” Indeed, it wasn’t until 2018 and 2019 that Munchee planned to incorporate the token into the Munchee App.

And anyway, continued the SEC, “[e]ven if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security.” Labels don’t matter, said the SEC, and dubbing a token as “utility” doesn’t obscure “the economic realities underlying a transaction.” Concludes the SEC: “All of the relevant facts and circumstances are considered in making that determination.”

Initial Lessons

ICO runners of the future can take at least the following pointers from the available details of Munchee’s demise:

1.       Show your work. If you have a great argument why your token is a utility token and not a security or why your ICO failed the Howey Test, deploy it.

2.       Don’t rely on labels. When assessing whether you’re selling a security, consider the entire transaction scenario, including the reasonable expectations, marketing, and economic realities floating around your ICO.

3.       Align your marketing. If your ICO and the purported utility of your tokens pivots on the embrace of a specific marketplace—i.e. the restaurant industry—it may look odd if your organization does not market within that sphere, but instead to typical securities investors and even hedge funds.  Munchee, according to the SEC, “likened MUN to prior ICOs and digital assets that had created profits for investors, and specifically marketed to people interested in those assets – and those profits – rather than to people who, for example, might have wanted MUN tokens to buy advertising or increase their ‘tier’ as a reviewer on the Munchee App.”

Next up: Centra, ATB, perhaps more...

ICO Contracts: Choice of Law, Venue Selection, and How Fraud Upends It All

Intro

ICOs are multiplying. Likely siphoning early stage VC funding, initial coin offerings have raised $4 billion in 2017. Bitcoin, the standard bearer of cryptocurrencies worldwide and the most common ICO currency, hit an all-time high nearing $18,000 in mid-December. With commensurate speed, lawsuits and regulator crackdowns have followed.

In particular, a series of lawsuits surrounding the startup Tezos may provide some guidance on ICO contracts. That is, not the smart contracts that administer the cryptocurrency-for-ICO token exchange at the core of certain ICOs, but the paper contracts which (hopefully!) set forth the terms and conditions of an ICO exchange, including limitations of liability, tax responsibilities, venue selection provisions, and more.

Background

Tezos threw a phenomenally successful ICO: $232 million raised by co-founders and spouses Arthur and Kathleen Breitmen, for an incomplete blockchain-based platform, in July 2017. Tezos’ haul shattered records for funds raised in an ICO—especially considering that these funds were ostensibly raised via bitcoin and ether, two currencies whose value continues to trend (substantially) up, raising the ICO’s ensuing estimated value to hit $1.3 billion.

Those Suits

Tezos faces at least five lawsuits, all class actions, filed in state and federal courts from Florida to California. One of these suits, captioned Gaviria v. Dynamic Ledger Solutions, Inc., et al., Case No. 6:17-CV-01959-ORL-40-KRS, attached to its complaint the Tezos Contribution and XTZ Allocation Terms and Explanatory Notes (“Tezos Terms”). The Tezos Terms, according to the complaint, memorialize the terms of the Tezos ICO’s fundraising offer—and are “unenforceable for a variety of reasons.” Gaviria, at 14.

Early Guidance

While the Tezos suits have yet to be resolved, and the validity of their arguments yet to be tested, guidance may be gleaned already for the fast-moving ICO space. In particular, the Tezos suits offer a lesson for ICO contract drafters on choice of law and venue selection provisions.

Choice of Law & Venue—Meet Fraud

Tezos, like certain other ICOs, sought to adjudicate litigation concerning their enterprise in a foreign jurisdiction. Via the very last provision of the Tezos Terms, any disputes “arising out of or in connection with” Tezos’ ICO are restricted “exclusively and finally [to] the ordinary courts of Zug, Switzerland.” Gaviria, at Exhibit A. Tezos’ choice of law was Swiss as well. Id.

Organizations running ICOs, like many other enterprises, don’t want to travel far to litigate, produce witnesses, and transport evidence. Hence, venue selection clauses. Also like many other organizations, those running ICOs seek regulatory havens. Jurisdictions they think align with the claims they might make (and field) should litigation arise. In fact, Kathleen Breitman told Reuters in June that Tezos chose to incorporate the Tezos Foundation in Zug since Switzerland “has a regulatory authority that had a sufficient amount of oversight but not like anything too crazy.” Each party’s assessment along these lines informs its agreement’s choice of law clause.

Generally, courts afford venue selection clauses significant deference, even when the chosen jurisdiction is a non-U.S. state. After all, the parties assumedly negotiated these clauses prior to signing the agreement. Today, the majority of federal courts (including those of the 2nd, 4th, 7th, 8th, 9th, 10th and 11th circuits—which include New York, Florida, and California) strictly enforce forum-selection clauses. The Supreme Court of the U.S. blessed this trend, ruling that “forum-selection clauses should control except in unusual cases.” Atlantic Marine Construction Co. v. United States District Court for the Western District of Texas, 571 U.S. 488 (2013). The same applies for choice of law clauses. The Restatement (Second) of the Conflicts of Laws provides that choice of law provisions are presumptively enforceable.

That said, how can Tezos be sued—multiple times—in California and Florida, at opposite ends of the country whose laws Tezos sought to avoid altogether?

Because fraud wasn’t part of the agreement.

Fraud features heavily across the Tezos litigation. For example, each in their own way, the Tezos suits allege that the utility tokens (i.e. markers of purchased services or access) that Tezos distributed to its “donors” in exchange for their “donations” during the Tezos ICO were actually unregistered securities, sold in violation of the Securities Act of 1933. Gaviria, at 31. By misleading ICO participants about the unregistered securities status of these tokens—a “material fact” highly relevant to the ICO participants—Tezos “fraudulently induced [the ICO class] to participate in the ICO.” Id., at 34. 

Fraud is kryptonite for forum selection clauses in federal court.  Decades ago the Supreme Court ruled that where enforcement of a forum selection clause would be “unreasonable and unjust, or that the clause was invalid for such reasons as fraud or overreaching,” it should not be enforced. The Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972). As for choice of law clauses, fraud can defeat those too. Carnival Cruise Lines, Inc. v. Shute, 499 U.S. 585 (1991).

Therefore, by claiming that the Tezos Terms were “induced by fraud and overreaching” (Gaviria, at 24), the plaintiffs at play may succeed in superimposing their own venue selection—Florida, for instance—over Tezos and its Swiss preferences.

Conclusion

ICOs operate for now in a regulatory gray-space. While crypto-entrepreneurs consider the securities status of their tokens, publish ambitious marketing materials, and hunt for ICO participants, they must also consider the jurisdictional impact their decisions might have on their ICO contracts—regardless of the law and venue they select.