Audet v. Fraser

          RULING ON CLASS CERTIFICATION

          MICHAEL P. SHEA, U.S.D.J.

         This case comes from the brave new world of cryptocurrency. The Plaintiffs are individuals who invested in products that ostensibly allowed them to share in the profits generated by “mining” - or solving complex mathematical problems to clear transactions in - digital currency. They are suing two companies that sold them these products and an individual who allegedly controlled these companies, claiming they were defrauded in violation of federal and state securities laws and the common law. I must decide whether the Plaintiffs may represent a class of such investors under Rule 23 of the Federal Rules of Civil Procedure. I conclude they may do so and thus grant their motion to certify the class, although I narrow the proposed class to address valid objections raised by the individual Defendant, who is at this point the only active Defendant in the case.^[1] I deny the Defendant's motion to exclude the Plaintiffs' expert declarations as moot because I do not rely on them to reach this conclusion.

         BACKGROUND^[2]

         I. Garza and Fraser

         In 2003, Homero Joshua Garza, who would later become the CEO of GAW Miners LLC (“GAW Miners”) and ZenMiner LLC (“ZenMiner, ” together with GAW Miners, “the Companies”), first met Stuart A. Fraser, the remaining active Defendant in this case. ECF No. 57 at ¶ 33. Over the next several years, Fraser, who was the Vice-Chairman of an investment bank called Cantor Fitzgerald, invested in various computer-related business ventures that Garza managed. Id. at ¶¶ 34-37. Although they did not formalize all of their business relationships, they had an understanding that Garza would serve as CEO of their respective companies and Fraser would serve as “the Board.” Id. at ¶ 34. They also had a close personal relationship. Id. at ¶¶ 39-42.

         II. The Companies

         Garza incorporated GAW Miners in March 2014 and served as its CEO. Id. at ¶ 46. When the company first started, Fraser invested approximately $135, 000 into the business; later that year, he provided the company with three loans of $200, 000 each. Id. at ¶ 47. He also provided GAW Miners and Garza short-term loans. Id. Fraser served as “the Board, ” id. at ¶ 46, and he and Garza each owned half the company under an earlier agreement concerning ownership of their joint ventures, id. at ¶ 48. They ultimately agreed to set aside 18% of the equity in GAW Miners for investors or employees. Id. A few months later, in July 2014, Garza incorporated ZenMiner. Id. at ¶¶ 20, 78. Garza and Fraser owned and controlled ZenMiner with Garza serving as the Managing Member. Id. at ¶¶ 20, 78.

         A. Virtual Currency

         The Companies offered various products and services related to virtual currency. Virtual currency is a digital representation of value that can be traded and functions as a medium of exchange. Id. at ¶ 25. Unlike fiat currency, which is money designated by a country as its legal tender, virtual currency does not have legal tender status in any jurisdiction. Id. The most widely adopted virtual currency is Bitcoin, but there are also other virtual currencies in use, known as “altcoins.” Id. An individual can “mine” virtual currency by using software to solve complex algorithms that validate groups of transactions in that virtual currency. Id. at ¶¶ 26, 28. Each unit of virtual currency has a “blockchain” that serves as an electronic public ledger of all transactions in that currency. Id. at ¶ 27. The first miner to confirm the transactions in a particular block and write them into the blockchain is rewarded with newly-issued virtual currency. Id. at ¶ 28.

         As competition among miners increases, more computer processing power becomes necessary to mine Bitcoin and other virtual currencies. Id. at ¶ 29. The processing power of a computer used to confirm virtual currency transactions is measured by its “hash rate, ” which represents the No. of calculations it can perform per second. Id. Sometimes, miners combine their computing power into mining pools to increase their chances of receiving a payout. Id. at ¶ 30.

         B. Hardware-Hosted Mining and Cloud-Hosted Mining

         Garza and Fraser founded GAW Miners to purchase virtual currency mining equipment from overseas manufacturers and resell it to customers. Id. at ¶ 75. Later, in June 2014, GAW Miners began selling “Hardware-Hosted Mining.” Id. at ¶ 77. Customers who purchased this product were told that GAW Miners would host computer hardware in its own datacenter, but allow customers to access and control their mining equipment via remote management software offered by ZenMiner. Id. at ¶ 77. GAW Miners then began offering “Cloud-Hosting Mining” in July 2014. Id. at ¶ 79. This was similar to Hardware-Hosted Mining, but customers were told they could control their mining equipment through a ZenCloud^[3] account instead of through remote management software. Id. In addition, those who purchased Cloud-Hosted Mining could direct their equipment to engage in mining only through one of the handful of mining pools offered on the ZenCloud website. Id. at ¶ 80. Customers of both products were told that they could end their hosted service at any time and receive their physical equipment in the mail. Id. at ¶ 81.

         The Plaintiffs allege that in reality, GAW Miners purchased very few pieces of mining equipment and did not have sufficient equipment to return to customers. Id. at ¶¶ 81, 89. They further allege that GAW Miners was not directing customers' computing power to any mining pools, but was instead operating a Ponzi scheme whereby it used incoming funds from new customers to pay existing customers the “returns” generated from mining activities. Id. at ¶¶ 89-91. Once customers began to complain that they could not see the increase in power in the mining pools they believed they had chosen to mine through ZenCloud, the Companies changed business models and offered customers the opportunity to convert their Cloud-Hosted machines into another product, described in detail below, called Hashlets. Id. at ¶ 94.^[4]

         C. Hashlets

         The Companies began selling Hashlets in August 2014. Id. at ¶ 95. Hashlet customers believed they were buying the right to profit from a slice of the computing power owned by the Companies, but without the right to acquire a specific piece of mining equipment (unlike customers of Hardware- and Cloud-Hosted Mining). Id. at ¶ 97. They were told that they could direct their Hashlets to mine in one of the particular mining pools available through ZenCloud and that they would receive a share of the payout earned by that pool's mining activity. Id. at ¶¶ 98, 100. The majority of investors bought Hashlets with U.S. currency or Bitcoin, but others bought Hashlets by converting the value of their Cloud-Hosted Mining equipment. Id. at ¶ 99. Investors were charged maintenance fees to pay for the upkeep of the equipment purportedly behind the Hashlets and these fees were deducted from their ZenCloud accounts daily. Id. at ¶ 101. They could also request withdrawals, in Bitcoin, from their accounts. Id. at ¶ 101.

         The Hashlets could mine for Bitcoin or Altcoin (“Bitcoin/Altcoin-Hashlets”). Id. at ¶ 105. But there were different types of Hashlets. Id. at ¶¶ 113-14. “Zen Hashlets” and “Prime Hashlets” were two of the most expensive types as they purportedly allowed investors exclusive access to ZenPool. Id. at ¶ 130. ZenPool was advertised as an advanced multi-pool-a pool that mines for both Bitcoin and Altcoin depending on the profitability of each coin-with the highest and most reliable payout. Id. at ¶ 129. The Plaintiffs allege that, contrary to these representations, there was no ZenPool. Id. at ¶ 131. Instead, they allege that GAW Miners determined the daily payout by examining the publicly-available payouts of other pools and picking a higher number. Id. . at ¶ 132.

         The Plaintiffs allege that the Companies dramatically oversold their computing capacity such that they did not engage in mining with even close to the amount of computing power that they sold in Hashlets. Id. at ¶¶ 108, 112. Specifically, they allege that the Companies falsely claimed that Hashlets were engaged in mining when they knew that few Hashlets were actually supported by mining activity. Id. at ¶¶ 117, 122. When customers inquired about where their hashing power was being used, Garza admitted that GAW Miners was not sending its computing power to the pools that investors had selected-he said that they were instead sending hashing power to the Companies' private pools, but assured customers that their payouts were still based on the pools they selected. Id. at ¶ 124. The Plaintiffs allege that this representation was also false as the Companies had nowhere near the amount of computing power required to support the units of hashing power that had been sold through Hashlets. Id. They allege that the Companies were running a Ponzi scheme by paying old investors primarily with funds from ongoing Hashlet sales. Id. . at ¶ 125.

         During the fall of 2014, the Companies experienced a drop in their revenue stream from selling Hashlets and announced new investment opportunities. Id. at ¶ 134.

         D. Hashpoints, Paycoin, Paybase, and HashStakers

         In November 2014, GAW Miners announced that it was planning to launch a new type of virtual currency called “Paycoin.” Id. at ¶ 136. Before launching Paycoin, GAW Miners offered its customers “Hashpoints, ” which were promissory notes that could be purchased or mined and then exchanged for Paycoin when Paycoin launched. Id. Customers could convert their Hashlets-which up until that point mined for Bitcoin and/or Altcoin-to mine for Hashpoints instead (“Hashpoint-Hashlets”). Id. at ¶ 138. Customers exchanged their Hashpoints for Paycoin when GAW Miners processed the conversion in December 2014. Id. at ¶ 149.

         The Plaintiffs allege that the Companies' “main motivation in offering Hashpoints was to shift customers' mining focus from bitcoin and altcoin to Hashpoints and Paycoin and to stave off bitcoin payments to Hashlet-holders that GAW Miners could not make.” Id. at ¶ 136. In marketing Paycoin, the Companies represented that they would ensure that the price of Paycoin would not drop below a $20 per coin floor, id. at ¶ 141, that banks and investment firms were providing financial backing, id. at ¶ 140, that there was significant financial support from outside investors, id., and that well-known merchants like Amazon and Wal-Mart would accept Paycoin, id. at ¶¶ 141-42. The Plaintiffs allege that none of these representations was true. Id. at ¶¶ 144, 153; ECF No. 97 at 38-39.

         Initially, Paycoin was placed into customers' ZenCloud account wallets. ECF No. 57 at ¶ 151. Then, GAW Miners introduced HashStakers, “digital wallets designed to hold Paycoin, ” which functioned as fixed-rate investment vehicles. Id. at ¶¶ 151-52. When customers deposited their Paycoin in HashStakers, the Paycoin would be “locked up” for 30, 90, or 180 days, and would yield a daily payout that was fixed by GAW Miners. Id. at ¶¶ 151-52. Customers could purchase HashStakers or “upgrade” their Hashlets to HashStakers. Id. at ¶ 151.

         GAW Miners also developed a central exchange and marketplace for Paycoin called Paybase. Id. at ¶ 153. However, Paybase was not ready when Paycoin launched. Id. In the interim, other virtual currency exchanges created their own Paycoin exchanges. Id. The price of Paycoin on these exchanges began to fall below $20. Id. at ¶ 154. Garza then announced that GAW Miners would “move the market” and used $35, 000 to trade Paycoin on an exchange called Cryptsy; Paycoin began trading above $20 per coin after this action. Id. GAW Miners also led customers to believe that it would take action to support the $20 floor when Paybase launched. Id. However, when Paybase launched it lacked many of the promised features - such as merchant adoption of Paycoin - and the price of Paycoin dropped. Id. at ¶¶ 155-56.

         III. SEC Investigation & Criminal Prosecution

         The Securities and Exchange Commission began investigating Garza and GAW Miners. ECF No. 107-1 at 223-227 (Exhibit A-42). Although it is unclear when the investigation began, CoinFire (a news organization that publishes news related to Bitcoin and other cryptocurrencies) published an article about it on January 19, 2015. Id.

         Then, on July 20, 2017, Garza pled guilty to wire fraud and stipulated to the following conduct:

1. From approximately May 2014 through January 2015, [Garza] operated a scheme to defraud victims out of money in connection with the procurement of virtual currency on their behalf.

. . .

3. [Garza] founded multiple companies that were used in connection with this scheme to defraud related to virtual currency, including, among others, GAW, GAW Miners, ZenMiner, ZenCloud.

4. [Garza's] companies sold miners, access to miners, the right to purchase a virtual currency called “paycoin, ” as well as “hashlets.” A hashlet entitled an investor to a share of the profits that GAW Miners and/or or ZenMiner would purportedly earn by mining virtual currencies using the computers that were maintained in their data centers. In other words, hashlet customers, or investors, were buying the rights to profit from a slice of the computing power owned by GAW Miners and ZenMiner.

5. To generate business as well as attract customers and investors, [Garza] made multiple statements related to the scheme, including, among others:

Statement	Truth
. . .	. . .
The hashlets the defendant's companies sold engaged in the mining of virtual currency.	The defendant's companies sold more hashlets than were supported by the computing power maintained in their data centers. Stated differently, the defendant's companies sold the customers the right to more virtual currency than the companies' computing power could generate.
The market value of a single paycoin would not fall below $20 per unit because the defendant's companies had a reserve of $100 million that the companies would use to purchase paycoins to drive up its price.	The defendant's companies did not have a reserve of $100 million and could not therefore drive up the value of Paycoin.

6. [Garza] along with others, acting through his companies, applied money his companies had made from new hashlet investors and used it to pay older hashlet investors money that the companies owed them based on the purported mining GAW Miners and ZenMiner had done on the investors' behalf. . . .

ECF No. 96-1 at 113-14 (Exhibit A-21).

         IV. The Lawsuit

         The Plaintiffs allege that the Companies (1) violated Section 10(b) of the Securities and Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5; (2) violated Sections 36b-29(a)(2) and 36b-4 of the Connecticut Uniform Securities Act; (3) violated Conn. Gen. Stat. § 36b-29(a)(1); and (4) engaged in common law fraud. ECF No. 57 at ¶¶ 167-173, 179-186, 192-195, 200-203. They allege that Fraser is liable as a control person or aider/abettor under (1) Section 20(a) of the Securities and Exchange Act, 15 U.S.C. § 78t(a); (2) Conn. Gen. Stat. § 36b-29(a)(2); (3) Conn. Gen. Stat. § 36b-29(c); and (4) common law fraud. ECF No. 57 at ¶¶ 174-178, 187-191, 196-199, 204-207. The Plaintiffs seek to certify the following class:

All persons or entities who, between August 1, 2014, and December 1, 2015 purchased or acquired Hashlets, Hashpoints, HashStakers, and Paycoin from GAW Miners and ZenMiner. Excluded from the Class are any defendants, any parent, subsidiary, affiliate, agent or employee of any defendant, any co-conspirator and any governmental entity.

         ECF No. 97 at 19. I held a hearing on the Plaintiffs' class certification motion on April 12, 2019.

         ECF No. 137 (transcript of hearing). After the hearing, I received supplemental submissions from the parties. See ECF Nos. 138-140.

         For reasons explained below, I modify the class definition and GRANT the Plaintiffs' motion to certify as to the following class:

All persons or entities who, between August 1, 2014 and January 19, 2015, (1) purchased Hashlets, Hashpoints, HashStakers, or Paycoin; or (2) acquired Hashlets, Hashpoints, HashStakers, or Paycoin by converting, upgrading, or exchanging other products sold by the Companies. Excluded from the Class are any defendants, any parent, subsidiary, affiliate, or employee of any defendant, any co-conspirator, and any governmental agency.

         Because the parties have not yet had a chance to comment on the modified class definition, they may, by July 5, 2019, file briefs not exceeding 10 pages in which they address any new issues raised by the modified class definition that the Court has not already addressed in this decision.

         LEGAL STANDARD

         “A plaintiff seeking certification of a Rule 23(b)(3) class action bears the burden of satisfying the requirements of Rule 23(a)-numerosity, commonality, typicality, and adequacy of representation-as well as Rule 23(b)(3)'s requirements: (1) that ‘the questions of law or fact common to class members predominate over any questions affecting only individual members' (the ‘predominance' requirement); and (2) that ‘a class action is superior to other available methods for fairly and efficiently adjudicating the controversy' (the ‘superiority' requirement).” In re Petrobras Securities, 862 F.3d 250, 260 (2d Cir. 2017) (quoting Fed.R.Civ.P. 23(a), (b)(3)). The Second Circuit “has also recognized an implied requirement of ascertainability in Rule 23, which demands that a class be sufficiently definite so that it is administratively feasible for the court to determine whether a particular individual is a member.” Id. (internal quotation marks and citation omitted).

         The party seeking class certification bears the burden of establishing each of Rule 23's requirements by a preponderance of the evidence. Amara v. CIGNA Corp., 775 F.3d 510, 519 (2d Cir. 2014). In determining whether a proposed class meets these requirements, the court must resolve any factual disputes and find any facts relevant to this determination. In re Initial Public Offerings Securities Litigation, 471 F.3d 24, 41 (2d Cir. 2006). The court's obligation to make such a determination “is not lessened by overlap between a Rule 23 requirement and a merits issue, even a merits issue that is identical with a Rule 23 requirement.” Id.

         “[I]n an alleged securities fraud case, when a court is in doubt as to whether or not to certify a class action, the court should err in favor of allowing the class to go forward.” In re Blech Securities Litig., 187 F.R.D. 97, 102 (S.D.N.Y. 1999); see also Colozzi v. St. Joseph's Hosp. Health Ctr., 275 F.R.D. 75, 82 (N.D.N.Y. 2011) (“Doubts about whether Rule 23 has been satisfied should be resolved in favor of certification.”). Accordingly, the Second Circuit “accord[s] greater deference to district court decisions granting class certification than to decisions declining to certify a class.” Johnson v. Nextel Commun. Inc., 780 F.3d 128, 137 (2d Cir. 2015).

         Moreover, district courts have “the ability . . . to alter or modify the class, create subclasses, and decertify the class whenever warranted.” Sumitomo Copper Litig. v. Credit Lyonnais Rouse, Ltd., 262 F.3d 134, 139 (2d Cir. 2001); see also Fed. R. Civ. P. 23(c)(1)(C) (“An order that grants or denies class certification may be altered or amended before final judgment.”). Thus, “[i]f factual or legal underpinnings of the plaintiffs' successful class certification motion are undermined once they are tested [on the merits], a modification of the order, or perhaps decertification, might then be appropriate.” Taylor v. The Hous. Auth. of New Haven, 267 F.R.D. 36, 62 (D. Conn. 2010) (internal quotation marks omitted), aff'd sub nom. Taylor ex rel. Wazyluk v. Hous. Auth. of City of New Haven, 645 F.3d 152 (2d Cir. 2011).

         DISCUSSION

         I. Class Definition

         Fraser argues that the proposed class includes members who lack Article III standing and do not meet the requirements of Rule 10(b) or the Connecticut Uniform Securities Act (“CUSA”). ECF No. 107 at 10-11. With regard to Article III standing, he argues that “the class would by definition include members who suffered no injury traceable to Defendants' alleged misconduct, ” and points to those who broke even or profited from their purchases as well as those who received them for free. Id. at 10. As to Rule 10(b), he argues that a plaintiff must either be a purchaser or seller of the securities at issue, and that the proposed class includes individuals who are neither. Id. at 10-11. Similarly, with regard to CUSA, he argues that only “the person buying the security” can bring suit. Id. As discussed below, I agree with some of these arguments and have modified the class definition accordingly; the remaining arguments raised by Fraser do not preclude class certification.

         A. Article III Standing

         In a class action, “only one of the named Plaintiffs is required to establish standing in order to seek relief on behalf of the entire class.” C States S.E. and S. W. Areas Health and Welfare Fund v. Merck-Medco Managed Care, L.L.C., 504 F.3d 229, 241 (2d Cir. 2007). And the court does “not require that each member of a class submit evidence of personal standing.” Denney v. Deutsche Bank AG, 443 F.3d 253, 263 (2d Cir. 2006). “At the same time, no class may be certified that contains members lacking Article III standing” and a “class must therefore be defined in such a way that anyone within it would have standing.” Id. at 264.

         Article III standing consists of three elements: (1) “an injury in fact, (2) that is fairly traceable to the challenged conduct of the defendant, and (3) that is likely to be redressed by a favorable judicial decision.” Spokeo, Inc. v. Robins, 136 S.Ct. 1540, 1547 (2016). Here, Fraser argues that the first element is not satisfied because the class “would by definition include members who suffered no injury traceable to Defendants' alleged misconduct.” ECF No. 107 at 10. More specifically, he argues that putative class members who “broke even or profited from their investments in the Companies' products, ” who “received them for free” through promotions, or who stole them as a result of “flaws in the Companies' systems, ” did not suffer any injury. ECF No. 107 at 10-11.

         He is correct that any individuals who stole products or received them for free would not have been injured by the alleged fraud. At oral argument, Plaintiffs' counsel stated that his intent in including in the class definition persons who merely “acquired” but did not purchase the products was to capture “rollovers” or “exchanges, ” such as persons who agreed to convert their Hashlets from Bitcoin-earning to Hashpoint-earning and thereby “acquired” Hashpoints. ECF No. 137 at 5. Accordingly, I revised the Plaintiffs' proposed class definition to more closely track this intent.

         I do not agree, however, that the class must also exclude those who “broke even or profited” from their investment as this concern goes to damages rather than standing. A plaintiff suffers an injury in a securities fraud case when she changes her position - such as by buying or selling - as a result of a material misrepresentation. See, e.g., CSI Inv. Partners II, L.P. v. Cendant Corp., 180 F.Supp.2d 444, 458 (S.D.N.Y. 2001) (“In a securities fraud action, [the] cognizable injury occurs at the time an investor enters . . . a transaction as a result of material misrepresentations.”) (quoting Zola v. Gordon, 685 F.Supp. 354, 363 n. 10 (S.D.N.Y. 1988)); EIG Energy Fund XIV, L.P. v. Petroleo Brasileiro S.A., 246 F.Supp.3d 52, 69 (D.D.C. 2017) (explaining that, for fraud claims brought under Rule 10b, “it is well established that a plaintiff suffers legal injury at the moment she makes her investment, not when she suffers actual losses, ” and that there is “no reason for differentiating between when an injury arises for common law fraud and for Rule 10b-5” as “standing to raise a Rule 10b-5 securities fraud claim . . . requires a plaintiff to have met both constitutional and statutory standing requirements”), aff'd, 894 F.3d 339 (D.C. Cir. 2018).

         B. Section 10(b)

         Fraser also argues that the proposed class includes members who cannot satisfy Section 10(b)'s requirements of a “purchase” or “sale” of securities. Specifically, he argues that the inclusion of those who acquired products by “‘mining' products, such as Hashpoints, ” or converting one product to another, such as “converting ‘Hashpoints' to . . . Paycoin, ” prevents certification of the class. ECF No. 107 at 11. I disagree. Section 10(b) states that it shall be unlawful “[t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe . . . .” 15 U.S.C. § 78j(b) (emphasis added). Rule 10b-5 contains similar language requiring a “connection with the purchase or sale of any security.” 17 C.F.R. § 240.10b-5. When the Supreme Court “has sought to give meaning to the phrase [“in connection with the purchase or sale”] in the context of § 10(b) and Rule 10b-5, it has espoused a broad interpretation.” Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 85 (2006) (emphasis omitted). “Under [its] precedents, it is enough that the fraud alleged ‘coincide' with a securities transaction-whether by the plaintiff or by someone else.” Id. “The requisite showing, in other words, is deception in connection with the purchase or sale of any security, not deception of an identifiable purchaser or seller.” Id. (internal quotation marks omitted). In addition, the Securities and Exchange Act defines the terms “purchase” and “sale” broadly:

(13) The terms “buy” and “purchase” each include any contract to buy, purchase, or otherwise acquire. For security futures products, such term includes any contract, agreement, or transaction for future delivery. For security-based swaps, such terms include the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing of rights or obligations under, a security-based swap, as the context may require.

(14) The terms “sale” and “sell” each include any contract to sell or otherwise dispose of. For security futures products, such term includes any contract, agreement, or transaction for future delivery. For security-based swaps, such terms include the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, ...