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Key takeaways
- Second Circuit has revived securities fraud suit against Binance in decision which, while decided narrowly on its facts, will be of interest to crypto-asset platforms operating on wholly or partly decentralized basis
- In deciding whether users of platform that disclaimed having any location had entered into binding agreement to purchase security tokens in United States, court considered and determined two key issues:
- First, it found that in this case, the particular decentralized infrastructure did not shield trading platform from U.S. securities laws because relevant transactions were “matched” on servers in United States, whereupon transactions became binding
- Second, it found purchasers adequately alleged United States as location of transactions as transactions purportedly were contracted for, placed, and sent by users in their respective U.S. states
- Court’s determination on these two factors at pleading stage is narrow and should be read as applying to facts before the court
- Court concluded that plaintiffs alleged facts that platform operated so that “irrevocable liability” was incurred or title was transferred within United States. Specifically, court found that plaintiffs had plausibly alleged facts showing that two transactional steps giving rise to irrevocable liability both occurred within United States: (1) individual plaintiffs transacted on company’s exchange from United States, and, under the company’s terms of use, their buy orders became irrevocable when sent; and (2) matching of plaintiffs’ buy offers with prospective sellers was done on U.S.-based servers.
In Lee et al. v. Binance, No. 22-972, 2024 U.S. App. LEXIS 5616, 96 F.4th 129 (2d Cir. March 8, 2024), the U.S. Court of Appeals for the Second Circuit reversed the district court’s dismissal of securities fraud class action claims against Binance, an international crypto-asset platform. The Court of Appeals held that purchasers plausibly alleged that transactions on the exchange which disclaimed having any physical location were domestic, thereby potentially subjecting Binance to U.S. securities laws.
Background
The dispute arose from purchases of “security tokens” (No. 22-972, slip op. at 7), a type of crypto-asset, sold on Binance’s platform. After the tokens lost significant value, purchasers residing in the United States filed suit alleging Binance unlawfully advertised, offered and sold the tokens without registering them as securities, in alleged violation of various state and federal securities laws.
Binance filed a motion to dismiss the case or, alternatively, to compel arbitration. In 2022, the trial court (U.S. District Court for the Southern District of New York) granted the motion to dismiss, finding that the claims constituted an impermissible extraterritorial application of U.S. securities laws, and that purchasers’ federal claims fell outside the applicable statute of limitations. Plaintiffs appealed.
Decision
The court identified two transactional steps where irrevocable liability was incurred.
- The transactions at issue were matched, and became irrevocable, on servers provided by Amazon Web Services, a U.S.-based company
- Purchasers transacted on Binance from U.S. states, with Binance’s terms of use specifying that buy orders became irrevocable when sent
The court also found that federal claims for purchases made during the year before filing suit were timely.
Importantly, the court noted that Binance presented a unique set of facts: Binance disclaimed a physical headquarters in any geographic location. Courts are concerned with the application of U.S. laws to foreign entities when that enforcement would conflict with regulations in the country where the entity is headquartered. That concern was not present in Binance, according to the court, as Binance was purportedly not subject to regulation by any regime.
As a result, this decision is a narrow one and suggests caution when a trading platform disclaims having any physical location. The Binance court acknowledged that under a different set of facts, “it may not always be appropriate to determine where matching occurred solely based on the location of servers the exchange runs on.” Slip op. at 21. Nevertheless, platforms running on a decentralized exchange should be cognizant that server location is among the factors a U.S. court may consider in determining whether securities claims may be brought against them.
The takeaway
Although the ruling in Binance is narrow and fact-specific, it highlights several factors that crypto-asset platforms should consider.
- Server location: The location of servers where transactions are matched can influence whether transactions are considered domestic. This is particularly relevant for decentralized exchanges that, unlike traditional exchanges, may not have a single location where matching occurs. Platforms that are not registered in a certain country and/or disclaim any physical location, as in Binance, must be aware that server location can give rise to securities claims under the irrevocable liability test.
- User agreements: Where user agreements are signed and where purchases are placed are also important factors in determining where irrevocable liability was incurred. As with server location, the location where buy orders are placed will not necessarily be sufficient on its own to allege irrevocable liability. The Binance court found that the terms of use signed by purchasers from their respective U.S. states, which specified that buy orders became irrevocable when sent, combined with domestic payments made by purchasers in the United States, were sufficient to allege irrevocable liability.
- Regulatory compliance: Platforms should be aware that decentralized infrastructure does not automatically shield them from U.S. securities regulations. The Binance court acknowledged the sovereignty and comity concerns that underlie the application of the presumption against extraterritoriality to Exchange Act claims in the Supreme Court decision, Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010). When a foreign exchange is registered in a certain country, the application of U.S. securities laws risks incompatibility with the applicable laws of that country. Those concerns, however, diminish if a platform disclaims a physical location altogether. In Binance, the court made clear that disclaiming a physical location and denying the application of any other country’s securities regulations will not shield a platform from U.S. securities laws.
Conclusion
The Second Circuit’s decision in Lee v. Binance underscores the importance of understanding how various factors, including server location and user agreements, affect the application of U.S. securities laws to decentralized trading platforms. While the ruling is narrow, it serves as a crucial reminder for platforms to carefully consider their operations and legal strategies to ensure compliance with relevant regulations.
Client Alert 2024-144
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