New York Appellate Court Confirms Attorney Generals Broad Investigative Powers into the Cryptocurrency Industry – JD Supra

On July 9, the Appellate Division of the Supreme Court of New York, First Department (First Department) issued a significant decision in James v. iFinex that confirmed the broad authority of the New York State Attorney General (NYAG) to investigate potential fraud. The decision is significant because it is the first appellate decision to apply the Martin Acts expansive powers to an NYAG investigation of foreign entities in the cryptocurrency industry. Given this decision, the NYAG now may be emboldened to use these powers to more actively police the emerging industry by seeking asset freezes and other preliminary injunctive relief against potential bad actors outside of the Empire State.

Background

The appeal stems from an NYAG investigation of whether respondents BFXNA Inc., BFXWW Inc., iFinex Inc. (collectively iFinex), Tether Holdings Limited, Tether Limited, Tether Operations Limited and Tether International Limited (collectively Tether Holdings) made untrue claims about their virtual currency, tether, which is issued by Tether Holdings and traded on the iFinex-operated trading platform, Bitfinex. Tether is a stablecoin that, according to Tether Holdings, is backed by U.S. dollar reserves. According to the First Departments decision, up until about March 4, 2019, Tether Holdings had represented that every tether is backed by one U.S. dollar, and any holder of tether may redeem it for one U.S. dollar at any time. After March 4, 2019, Tether Holdings changed its representation on its website to state that, while every tether is still valued at one U.S. dollar, tether is backed by Tether Holdings reserves, which include unspecified currency, cash equivalents, and other assets and receivables from loans made by Tether Holdings to third parties, including to affiliated entities.[1] Notably, each respondent is: (i) incorporated outside of the United States; (ii) neither headquartered nor registered for service of process in New York; (iii) majority owned by nonparty Digfinex Inc.; and (iv) operated by a small group of executives and employees, some of whom are or have been located in New York.[2]

The NYAG initiated the investigation in November 2018 due to a concern that respondents lacked sufficient liquidity to permit customers to redeem tether at the represented value.[3] During the course of the investigation, the NYAG learned certain concerning facts, including that: (i) a third-party foreign entity, which processed customer deposits and withdrawals for iFinex, had refused to provide iFinex with nearly $1 billion of their commingled client and corporate funds; (ii) Tether Holdings had transferred $625 million to iFinex; and (iii) iFinex took a $900 million line of credit from Tether Holdings (despite the NYAGs expressed concerns).[4]

Based on these revelations, the NYAG sought and obtained an ex parte order pursuant to the Martin Act on April 24, 2019, compelling respondents to produce certain documents and staying them from (i) making any claims on the U.S. dollar reserve held by Tether Holdings, (ii) making any payments to any individual associated with respondents from the Tether Holdings reserve, and (iii) altering or destroying any documents related to the investigation.[5] The motion court thereafter granted respondents motion to modify the ex parte order but rejected their attempt to vacate it.[6] The respondents then moved to dismiss for, among other things, lack of subject matter jurisdiction and lack of specific personal jurisdiction, which the motion court rejected, and the respondents appealed this decision.[7]

Decision

On appeal, the First Department rejected respondents arguments and affirmed the motion courts order as follows.

The Martin Act Broadly Empowers the NYAG. From the outset, the First Department recognized the NYAGs broad powers under the Martin Act to seek an ex parte order pursuant to General Business Law 354 compelling documentary and testimonial evidence and enjoining respondents as appropriate.[8] Upon the NYAG making an application for the order, it is the duty of the justice of the supreme court to whom such application for the order is made to grant such application.[9] In the application for such an order, the NYAG may merely show, upon information and belief, that the testimony of such person or persons is material and necessary. The First Department concluded that once a court has issued such an order, its authority is limited to only considering a partys motion to modify or vacate the order.[10] Given this, the respondents motion to dismiss the order was without precedent.[11]

Tether Is a Commodity Under the Martin Act. The First Department noted that respondents did not appeal the motion courts order rejecting vacatur, which found subject matter jurisdiction, so the issue of subject matter jurisdiction was not before it. Even if it were to consider their argument, the First Department held that the Martin Acts definition of commodities as including any foreign currency, any other good, article, or material is broad enough to encompass tether.[12] The First Department explained that federal courts and the Commodities Futures Trading Commission have found that virtual currencies are commodities under the Commodities Exchange Act, which defines the term more narrowly than does the Martin Act.[13]

Respondents Had Sufficient Minimum Contacts with New York. The First Department found that respondents had sufficient minimum contacts with New York for the purpose of a Martin Act investigation. The First Department reasoned that (i) New York-based customers used the Bitfinex platform to trade tether, (ii) one of respondents executives resided and conducted business in New York, (iii) respondents had active bank accounts in New York, and (iv) respondents retained New York professional firms to review tether cash reserves and to make public statements on respondents behalf about the Bitfinex platform and tether cash reserves.[14]

Takeaways

Regardless of how the investigation concludes (no charges have been brought yet, and it still is possible that none will be), this decision illustrates the wide range of activity and persons that are subject to the NYAGs investigative powers pursuant to the Martin Act. Given this, foreign persons operating in the blockchain industry should be aware of the following implications from the iFinex decision.

Lower Personal Jurisdiction Standard for Investigations. As noted by the First Department, the standard for establishing personal jurisdiction for an investigation is far lighter than for a lawsuit.[15] The First Department held that the NYAG may properly investigate a foreign entity if she has a reasonable basis for believing that [it] has violated a New York statute.[16] Because investigative subpoenas may then be used to obtain information to further support jurisdiction for lawsuits,[17] the Martin Act is a powerful tool that the NYAG may use to pursue civil and criminal charges against persons within and outside of the states borders.

Multiple Personal Jurisdictional Triggers. As the iFinex decision illustrates, personal jurisdiction is a factual determination and there are many facts and circumstances that may justify the use of the Martin Act even on foreign persons. The threat of personal jurisdiction being found in New York is particularly acute for the blockchain industry, in which so many operations may touch on the statethrough marketing, transactions, financing or other triggers. The online nature of the industry, which allows it to reach New York residents whether or not they are directly solicited, is a further challenge for many foreign persons who do not otherwise believe they are subject to the states jurisdiction.

The Martin Act Applies to Virtual Currencies. The First Department unequivocally held that the Martin Act applies to virtual currencies because they fit squarely within its broad definition of commodities. Although the First Department did not decide whether tether is also a security,[18] the fact that the Martin Act applies to both commodities and securities suggests that it may be difficult to persuade a court that blockchain-based cryptographic assets are not governed by the Act. While there may be situations in which a cryptographic asset is neither a security nor a commodity for purposes of the Martin Act, the iFinex decision indicates that products with features similar to tether may likely be considered commodities.

* * *

[1] James v. iFinex Inc., 2020 NY Slip Op. 03880 at 2-3 (July 9, 2020) (internal alteration removed).

[2] Id. at 3.

[3] Id.

[4] Id. at 4-5.

[5] Id. at 5.

[6] Id. at 6.

[7] Id.

[8] Id.

[9] New York Consolidated Laws, General Business Laws 354.

[10] James, at 6.

[11] Id. at 6-7.

[12] Id. at 8 (emphasis and internal citation omitted).

[13] Id.

[14] Id. at 10-11 (emphasis omitted).

[15] Id. at 12-13.

[16] Id. at 13 (quoting Matter of La Belle Creole Intl., S. A. v. Attorney General of the State of N.Y., 10 N.Y.2d 192, 198 (1961)).

[17] Id. at 12-13.

[18] Id. at 8 n.2.

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New York Appellate Court Confirms Attorney Generals Broad Investigative Powers into the Cryptocurrency Industry - JD Supra