Monday, August 26, 2019

Personal and subject matter jurisdiction issues moot during cryptocurrency cover-up investigation

By Jay Fishman, J.D.

A New York trial court denied two virtual currency entities’ motion to dismiss the New York Attorney General’s (AG) fraud claim against them under New York’s state securities law (the Martin Act) because the entities’ argument that the AG lacked personal and subject matter jurisdiction over them did not apply during the AG’s ongoing investigation and could be decided only at the time the civil action went to trial (In the Matter of the Inquiry of Letitia James, August 19, 2019, Cohen J.).

Previously, the court issued the AG’s requested order demanding that the entities, an asset trading platform operator (Bitfinex) and a virtual currency issuer (Tether), cease their ongoing activities and produce specified documents while the AG’s office investigated whether they had defrauded New York investors in violation of the Martin Act. The AG’s investigation intended to prove that Bitfinex had drained $700 million from Tether’s cash reserves while covering up the $850 million loss by repeatedly telling investors for years that their funds were intact in those reserves and backed up one-to-one by Tether’s virtual currency.

Contentions. Bitfinex and Tether contended that they were not required to produce any documents since their businesses comprised an off-shore cryptocurrency exchange without sufficient connection to New York to trigger personal jurisdiction. They additionally argued that the AG’s “extraterritorial” investigation into their business activities lacked subject matter jurisdiction because cryptocurrency is neither a “security” nor a “commodity” under the Martin Act. They further stated that the AG’s primary investigation pertains to their recent issuances of lines of credit which have no New York connection from 2017 to the present because they changed their written policies to bar all U.S. residents from opening accounts on their sites, and since that time have neither advertised nor marketed to New York or other U.S. individuals or entities.

The AG countered that her ongoing investigation revealed that Bitfinex and Tether: (1) allowed some customers located in New York to transact on the Bitfinex trading platform after January 2017; (2) knowingly permitted New York-based traders to use Bitfinex; (3) agreed to loan Tether to a New York-based virtual currency trading firm as late at 2019; (4) opened accounts and used services at New York-based banks; and (5) had a physical presence in New York until at least 2018 through an executive who resided in and conducted work from the state.

Personal jurisdiction. The court began by proclaiming that the Martin Act does not prohibit Bitfinex or Tether from challenging personal jurisdiction during a pending investigation. It also does not prohibit the court from deciding the personal jurisdiction issue while an investigation is ongoing. But the court said that to decide the personal jurisdiction question, it must look to Section 354 of New York’s General Business Law, which provides that once the AG presents an application for an order allowing an investigation under the Martin Act, a New York supreme court judge has a duty to grant the application. The court supported the statute by reciting part of the decision in the 1961 New York La Belle Creole Intl. S.A. v. Attorney General case which explained that “a foreign corporation’s immunity from civil suit in New York, on the ground that it is not doing business there, does not mean that it is immune from investigation by the Attorney General in an inquiry to determine whether it is violating the laws of this State. As long as that official has a reasonable basis for believing that the corporation violated a New York statute, the official is not prevented by the due process class of the Federal Constitution from exercising his or her power of subpoena and initiating an investigation to ascertain the facts.”

In this case, the court concluded that: (1) the La Belle court’s rationale supported the exercise of personal jurisdiction to facilitate the AG’s gathering of information, even if Bitfinex’s and Tether’s contacts fell short of what would be required to bring a civil action under the Martin Act; and (2) as set forth in the May 16, 2019 order, the AG established a reasonable basis for proceeding with her investigation and is entitled to gather information from Bitfinex and Tether to determine whether they have violated the Martin Act. On this matter of personal jurisdiction, however, the court continuously distinguished between the investigation phase of a case and that case once it is brought to trial, declaring that at trial Bitfinex and Tether might successfully argue a lack of personal jurisdiction over them.

Subject matter jurisdiction. On the subject matter jurisdiction question, the court addressed Bitfinex’s and Tether’s contention that as extraterritorial entities, they fell outside the scope of the Martin Act. But the court debunked this argument, remarking that “arguments about extraterritorial reach are unavailing where, as here, the statute is being utilized to investigate domestic conduct.” The court further stated that the Martin Act “should be liberally construed to give effect to its remedial purpose of protecting the public from fraudulent exploitation in the offer and sale of securities.” The court advised that the decision granting the AG’s order is the law of the case while her investigation is ongoing, so this court will not truncate the investigation at this stage.

The court also addressed the reasonableness of the AG’s investigation, pointing out that it could still determine a lack of subject matter jurisdiction at this investigation stage if the investigation has, in fact, uncovered bits of totally far afield material not relevant to the case. However, the court noted that the AG has not only found at least five personal jurisdiction connections between Bitfinex/Tether and New York, but on the subject matter jurisdiction question has also uncovered facts strongly suggesting that Tether’s cryptocurrency transactions have characteristics common to securities and commodities. These AG factual findings, said the court, give weight to her argument that she needs more time to uncover additional facts showing security/commodity characteristics before a final determination can be made about whether Bitfinex’s and Tether’s business activities are covered by the Martin Act. For the above reasons, the court found a prevalence of subject matter jurisdiction during this investigation phase of the case, but again stated that when the case become a civil action for trial, Bitfinex and Tether might very well show that the Martin Act lacks subject matter jurisdiction over them.

The case is No. 450545/2019.