Second Circuit Rules US Securities Laws Reach C

Second Circuit Rules U.S. Securities Laws Reach Certain Digital Asset Transactions

In Short 

The Situation: The Second Circuit recently revived a securities class action against the crypto exchange Binance Holdings Ltd., holding that plaintiffs plausibly alleged their transactions on the exchange were "domestic," as required by the U.S. Supreme Court's decision in Morrison v. National Australia Bank Ltd. 

The Holding: The court held that plaintiffs plausibly alleged they became irrevocably liable in the United States—making the transactions domestic—for two reasons: (i) the transactions were allegedly "matched" on Amazon Web Services ("AWS") servers located in the United States; and (ii) plaintiffs allegedly placed trade orders and sent payments from the United States.

Looking Ahead: Although it provides limited new appellate guidance relevant to digital asset transactions on platforms with decentralized operations, Binance is unlikely to permit plaintiffs to satisfy domesticity by alleging that otherwise foreign exchange transactions were processed through U.S. servers. The Second Circuit's server analysis is fact-specific to Binance's allegedly anational structure and decentralized operations. 

Morrison's Domesticity Requirement

As discussed in our prior Commentaries, the Supreme Court's 2010 decision in Morrison restricted the application of U.S. securities laws to: (i) "transactions in securities listed on domestic exchanges"; and (ii) "domestic transactions in other securities." In its 2012 Absolute Activist decision, the Second Circuit held that for transactions to qualify as domestic, "irrevocable liability" must attach within the United States. The court also clarified that, when analyzing transactions that do not take place on an exchange, it looks to "facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money" to determine when and where irrevocable liability attaches.

Since then, the Second Circuit has issued several decisions refining the test set forth in Absolute Activist. For example, in Choi v. Tower Research Capital LLC, the court held that irrevocable liability may attach between different parties and intermediaries at different times and in different places. In Choi, while the transactions were cleared and settled on the Korea Exchange, they were first matched on CME Globex, a platform located in Illinois. The court concluded that irrevocable liability between the buyer and seller attached at matching, not clearing and settling (when the clearinghouse's irrevocable liability attached). And because matching occurred in the United States, the trades were held to be domestic. 

The Binance Decision 

Although several lower courts have analyzed the domesticity of crypto transactions, no single test emerged from those cases, and Binance is the first appellate decision in this fast-developing space. Binance involved alleged violations of federal securities and state Blue Sky laws in connection with secondary sales of several digital assets. The district court granted Binance's motion to dismiss for three reasons: (i) the claims were impermissibly extraterritorial; (ii) the claims were untimely; and (iii) there was an insufficient nexus between the allegations and the states whose laws governed absent class members' claims. The Second Circuit reversed all three grounds for dismissal.

1. Extraterritoriality: The Second Circuit relied heavily on its Choi decision's holding that, in exchange trading, irrevocable liability can attach when transactions are "matched" between the parties to the lawsuit. Binance presented a new question, however: where does matching happen on a digital asset exchange with allegedly "no physical headquarters in any geographic jurisdiction" and decentralized operations? The court reasoned that, even if Binance lacks a physical location, "the answer to where matching occurs cannot be 'nowhere.'" Because Binance "has not registered in any country," claims to have "no physical location," and "denies the applicability of any country's securities regime," the court ruled that plaintiffs satisfied domesticity "at this early stage in the case" by plausibly alleging that matching occurred on Binance's servers, which were allegedly located in California. In doing so, the court signaled that server location will likely become a key discovery issue in cases involving digital asset platforms that disclaim ties to any geographic jurisdiction.

  • Despite its holding, Binance should not make server location dispositive in cases outside the context of unregistered and purportedly anational exchanges. The court stressed that "[i]t may not always be appropriate" to rely on server location, such as in a case "based on the happenstance" that a foreign-registered exchange transaction "was initially processed through servers located in the United States." Similarly, courts likely will continue to dismiss extraterritorial CEA and RICO claims even if initial transaction processing or communication routing occurs on U.S. servers.  
  • The court also found domesticity for a "second, interrelated reason." Because Binance disclaimed being physically located in any particular jurisdiction, the court had "particular reason" to find irrevocable liability attaching in the U.S. based on plaintiffs' "plausible" allegations that they entered into Binance's Terms of Use, placed trade orders they could not unilaterally revoke, and sent payments from the United States. 

2. Timeliness: The district court had also dismissed all of plaintiffs' federal securities claims as untimely. But the Second Circuit reversed as to the subset of claims based on purchases made within the year before plaintiffs filed suit. The court held, under the Second Circuit's decision in Diskin v. Lomasney & Co., that these claims only accrued when plaintiffs had the ability to bring suit, which necessarily post-dated plaintiffs' purchases. 

3. Absent Class Members: Finally, the Second Circuit also vacated as premature the district court's dismissal of absent class member claims brought under the laws of states other than those where the named plaintiffs resided.  The court held this to be a Rule 23(b)(3) predominance question to be decided later.

Three Key Takeaways

  1. Following Binance, lower courts faced with exchanges with decentralized operations claiming to be outside "any country's securities regime," may consider: (i) the location of servers on which transaction matching occurs; (ii) where contracts are formed; (iii) where purchase orders are placed; (iv) where passing of title occurs; and (v) where money is exchanged. Server location could become a significant discovery issue in such cases.
  2. The Second Circuit's decision signals that such purportedly anational platforms will not escape the application of U.S. securities laws by disclaiming every sovereign jurisdiction's securities laws and regulations. 
  3. Given the Binance court's particular concern with not allowing a platform to be outside the reach of all national laws, Binance does not signal a sea change in how courts should approach the extraterritoriality analysis in more traditional contexts. 
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