On February 26, 2025, the United States Court of Appeals for the Second Circuit affirmed the dismissal of federal securities claims against the developers of a decentralized cryptocurrency exchange and the exchange’s venture capital investors.
Risley v. Universal Navigation Inc., 2025 WL 615185 (2d Cir. Feb. 26, 2025). As discussed in our prior
post, plaintiffs alleged that defendants were aware of the trading of allegedly fraudulent “scam tokens” on the exchange but ignored those “scam tokens” to profit from transaction fees, and further alleged that the “scam tokens” constituted unregistered securities. The district court dismissed the action in its entirety. The Second Circuit agreed that defendants, as developers of a decentralized cryptocurrency exchange, could not be liable under the federal securities laws for alleged fraud perpetrated by third parties on the exchange. The Second Circuit, however, vacated the dismissal of plaintiffs’ state law securities and common law claims and remanded for the district court to consider those claims in the first instance.
The exchange’s trading platform operated through a system of self-executing and self-enforcing “smart contracts” that autonomously write the terms of an agreement between the traders of a cryptocurrency token, eliminating the role that exchanges, broker dealers, and their banks, lawyers, or accountants would traditionally play in facilitating trades and offerings.
Id. at *2. Plaintiffs contended that the tokens were unregistered securities that were offered and sold in violation of Sections 5 and 12(a)(1) of the Securities Act of 1933.
Id. Plaintiffs also asserted that the contracts created on the platform were subject to rescission pursuant to Section 29(b) of Securities Exchange Act of 1934.
Id. Based on the same allegations, plaintiffs included claims under the securities and fraud laws of Idaho, North Carolina, and New York and sought certification for subclasses of citizens of Idaho and North Carolina.
Id. at *1.
The Second Circuit assumed
arguendo that the tokens in question were
bona fide securities, but nevertheless dismissed the Securities Act claims, holding that plaintiffs failed to adequately allege that defendants either were the direct sellers of the tokens or that they actively solicited the sale of the tokens to plaintiffs.
Id. at *2. The Court rejected plaintiffs’ argument that defendants should be deemed to be direct sellers of the tokens at issue. The Court explained that claims under Section 12(a)(1) and Section 5 of the Securities Act do not extend to participants that are “collateral to the offer or sale.”
Id. at *3 (citing
Pinter v. Dahl, 486 U.S. at 650, 651 (1988)). The Court concluded, analogizing to the role of the Nasdaq or the New York Stock Exchange, that the smart contracts in question merely functioned to execute trades and were therefore collateral to the token sales. The Court further noted that, even if the exchange were deemed to assume title to the tokens for a split-second while executing the transactions—as plaintiffs argued—that was insufficient to state a claim because Securities Act liability does not extend to those “remotely related to the relevant aspects of the sales transaction” such as those whose “involvement is only the performance of their professional services.”
Id. In addition, the Court rejected plaintiffs’ argument that defendants actively solicited the transactions by making social media posts touting the safety of the exchange platform. The Court explained that such conduct was “too attenuated” from the actual token sales at issue.
Id.
With respect to the Exchange Act claims, the Second Circuit held that plaintiffs did not adequately allege the existence of a contract that could be rescinded under Section 29(b) of the Exchange Act. The Second Circuit emphasized that the applicable transaction contracts were not between plaintiffs and defendants, but rather between plaintiffs and the tokens’ issuer or liquidity provider.
Id. at *4. The Second Circuit determined that, even if plaintiffs were correct that the smart contracts were unique to each transaction, the smart contracts were not subject to rescission because they were “more analogous to overarching user agreements than to securities transactions conducted by traditional broker dealers.”
Id. The Second Circuit agreed with the district court that “it ‘defies logic’ that a drafter of a smart contract, a computer code, could be held liable under the Exchange Act for a third-party user’s misuse of the platform.”
Id.
However, the Second Circuit agreed with plaintiffs that the district court erred in dismissing their state law claims. After dismissing the federal securities law claims, the district court declined to exercise supplemental subject matter jurisdiction over plaintiffs’ state law claims. The Second Circuit concluded, however, that plaintiffs had properly pleaded original diversity jurisdiction over those claims under the Class Action Fairness Act of 2005 (“CAFA”) because, under CAFA, district courts have original subject matter jurisdiction over putative class actions alleging damages above $5 million and a class of more than 100 persons where any member of the putative class is a citizen of a different state from any defendant.
Id. at *4. The Court therefore vacated the dismissal of the state law claims and remanded for the district court to consider those claims in the first instance.
Id
