First Department Upholds NY AG's Authority to Investigate Virtual Currency Under the Martin Act
The Development: The First Department held that the New York Attorney General ("NYAG") has broad authority to investigate virtual currency companies, while narrowing the scope of jurisdictional challenges that can be made to an ex parte request for documents and testimony, and to enjoin respondents from taking certain further action, pursuant to NY GBL 354.
The Result: In the first appellate decision to apply the NYAG's investigative authority under the Martin Act to the cryptocurrency industry, the Appellate Division of the Supreme Court of New York, First Department issued a decision on July 9, 2020 in James v. iFinex that confirmed the NYAG's wide latitude to investigate companies pursuant to the Martin Act.
Looking Ahead: The Appellate Division's decision underscores the recent focus by the NYAG to police both the traditional banking industry as well as the fintech space. Companies hoping to challenge the NYAG's authority to investigate securities and commodities fraud pursuant to the Martin Act face significant obstacles, as reflected in the First Department's procedural and substantive findings.
In November 2018, the NYAG initiated an investigation into respondents BFXNA Inc., BFXWW Inc., and iFinex Inc. (collectively, iFinex) regarding tether, a virtual currency. The investigation was prompted by liquidity concerns regarding the ability to redeem tether at the represented value. During the course of the investigation, the NYAG requested and obtained an ex parte order pursuant to General Business Law ("GBL") § 354, compelling respondents to produce documents and staying certain further actions pending the ongoing investigation into tether.
Respondents initially moved to quash or modify the ex parte order, and the modification request was granted in part. Respondents then moved to dismiss the ex parte order for, among other things, lack of specific personal jurisdiction and lack of subject matter jurisdiction, arguing that tether is not a security or commodity, and that iFinex wasn't engaged in any business activity purposefully directed at New York. That motion was denied, leading to the instant appeal.
On appeal the First Department affirmed the lower court's denial of respondents' motion to dismiss for lack of subject matter jurisdiction and lack of personal jurisdiction, finding that the trial court properly rejected respondents' attempts to limit the NYAG's investigative authority under the Martin Act.
The First Department began its decision with a discussion of the broad powers of the NYAG under the Martin Act to seek an ex parte order compelling the production of documents and testimony and enjoining respondents. The decision notes at the outset that the case raises important issues regarding the scope of the NYAG to investigate fraud under the Martin Act, and held that the trial court "properly rejected the attempts by respondents to limit [the NYAG's] lawful authority to protect New York residents."
The First Department held that, under the Martin Act's statutory scheme, once a court has issued an ex parte order pursuant to a GBL 354 application, it has no further role in the NYAG's investigation. Thus, the issuing court's authority is limited to considering a responding party's motion to modify or vacate the order. On that basis, the First Department held that there was no action or proceeding for the court to "dismiss" when respondents filed their motion to dismiss.
Nevertheless, the Court considered respondents' personal and subject matter jurisdiction arguments on the merits, and held that:
- Tether is a "commodity" under the Martin Act. The First Department held that that the Martin Act's definition of commodities was broad enough to encompass virtual currencies like tether, because commodities include "any foreign currency, any other good, article, or material." On that basis, the First Department held that the NYAG's documentary and other requests related to tether fell squarely within the subject matter jurisdiction of the NYAG's investigative authority.
- iFinex had sufficient minimum contacts in New York to exercise specific personal jurisdiction. The First Department held that there were multiple bases for exercising personal jurisdiction over iFinex, including previous trading by New York‑based customers and the New York residence and conduct of business of one of respondents' executives within the state. The Court noted that the NYAG can establish personal jurisdiction to exercise its investigative authority by a "far lighter showing" than would be required to bring a lawsuit. As the Court also noted, this means that a Martin Act Investigation can be used to develop the information required to establish personal jurisdiction for a lawsuit.
- The alleged deficiencies in service of respondents was a mere technical infirmity that could not support a finding of lack of personal jurisdiction.
The NYAG's investigation of iFinex is still underway; no charges have been brought to date.
Two Key Takeaways
- The First Department has once again confirmed the broad reach of the NYAG's investigative powers of the Martin Act, reading an expansive definition of the word "commodities" to include virtual currencies. This decision serves to further emphasize the significant reach of the NYAG in policing both traditional and non‑traditional areas of the financial sector and suggests that other virtual currencies and assets with similar features will likely be considered commodities in the future. The investigation underpinning this decision also provides a window into how the NYAG's office views cryptocurrencies and may signal future scrutiny by the office of the cryptocurrency industry.
- The First Department's holding that the issuing court's authority is limited to considering a party's motion to vacate or modify an ex parte order pursuant to GBL 354 means that respondents will need to include within a motion to vacate or modify all contemplated challenges, including jurisdictional challenges, to the order. Targets of investigation should also be evaluating the timing of raising any issues concerning personal jurisdiction and subject matter jurisdiction when considering whether to file a motion to modify or vacate. Any jurisdictional challenges may be unlikely to succeed in light of the court's finding that a "lesser" showing is needed to establish jurisdiction under the Martin Act than is required in a lawsuit. It remains to be seen whether subject matter jurisdiction will ultimately be found to also require a "lighter" showing for an investigation under the Martin Act than traditional litigation.
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