Not Legal Advice, 9/22/19 – self-proclaimed architect of the “Zug Defence” arrested, ICOBox sued, Section 230 limited by the 9th Circuit

Welcome back to this week’s edition of Not Legal Advice!

Between delivering the keynote at blockchain day of Stamford Innovation Week and getting ready for Crypto Springs, I’ve been pretty busy, so this week’s newsletter is going to be on the short side (a mere 1,800 words). This week:

  1. Self-proclaimed architect of the “Zug Defence” (or “Defense” for Americans) arrested
  2. ICOBox sued for selling unregistered securities, fraud, and operating as an unregistered broker-dealer; Paragoncoin resurfacts
  3.  Enigma v. Malwarebytes: 9th Circuit says Section 230 doesn’t apply to deliberately anticompetitive conduct

1. Self-proclaimed architect of the “Zug Defence” arrested

Last week brought us the news that Steven Nerayoff – early Ethereum advisor, sometimes Ethereum co-founder, and current one-of-those-guys-who-is-on-twelve-different-token-boards, was arrested and charged in the Eastern District of New York with extortion.

Although of course Nerayoff and his alleged co-conspirator, a fellow named Michael Hlady who previously was convicted of defrauding a group of nuns in Worcester, Mass (no, really), are innocent until proven guilty, it suffices to say that the allegations contained in the indictment do not portray either defendant in an especially flattering light.

Of wider significance here from the observer’s viewpoint is the fact that someone with intimate knowledge of the Ethereum Foundation’s early legal strategy and, in particular, the contents of a legal opinion which, according to CoinDesk, is said to have cost $200,000, payment of which Nerayoff reportedly guaranteed with his own money, is now in federal custody.

The issuance of this legal opinion is worth re-examination, at the very least for historical purposes if nothing else. Apart from the obvious fact that $200,000 is rather a lot of money to pay for a legal opinion, the issuance of that opinion – which I presume authorized the sale, otherwise why pay $200k for it – arguably set off the ICO boom as we know it. The fact that Ethereum proceeded with legal air cover and was such a wild, runaway success encouraged other law firms, large and small, to then take a view on subsequent offerings in order to gain market share and marquee clients.

Ethereum was the first of many coin issuers to set up shop in Zug, Switzerland, known now as “crypto valley,” presumably under the theory that Swiss residence and legal structures would immunize them from U.S. law. This tactic, referred to in jest by cryptolawyer OGs as the “Zug Defence,” is rumored to involve establishing a Swiss Stiftung, or foundation, obtaining tax opinions from a Swiss law firm that the token-product is to be treated as a software product for tax purposes, and, in Ethereum’s case, obtaining a second, supplemental opinion which presumably set out the U.S. legal position (if the rumors are true). Although I have not read it, to the extent that opinion authorized the Ethereum pre-sale to occur in the U.S. without requiring the Ethereum Foundation to register the tokens or avail itself of an exemption, it would have been, in my professional opinion, legally incorrect. This conclusion is based on the SEC’s 2018 Paragon and AirFox settlements, which we may presume form the template for all enforcement actions which will follow, and in relation to which the Ethereum pre-sale, in hindsight, does not appear to have been materially different.

Generally speaking, a practitioner who possesses even one whit of conservatism in their bones will tell you that the so-called “Zug Defence” is not much of a defence at all, to the extent that the transaction or scheme touches the U.S.  or captures the U.S.’ attention. Although the statute of limitations for the Ethereum Foundation qua token issuer under the Securities Act of 1933 has run, their operations continue. When a supposed non-profit in Switzerland magically creates $20+ billion out of thin air, you can be sure this does not go unnoticed.

This is accordingly a story to watch.

marmot_2.jpg
This marmot is on Mt. Rainier, not in Switzerland. This marmot follows U.S. securities laws.

2. SEC sues ICOBox for selling unregistered securities, fraud, and operating as an unregistered broker-dealer; Paragoncoin resurfaces

In other federal-agencies-on-the-warpath news, the U.S. Securities and Exchange Commission sued ICOBox and its founder last week for allegedly conducting an unregistered coin offering, engaging in fraud in relation to that coin offering, and operating as an unregistered broker-dealer in relation to other coin offerings launched using its platform.

Attorneys can spot plausibly deniable sarcasm from 1,000 yards, and the complaint does not disappoint:

ICOBox proclaims to be a “Blockchain Growth Promoter and Business Facilitator for companies seeking to sell their products via ICO crowdsales” —in other words, an incubator for digital asset startups. A self-described blockchain expert, Evdokimov, has acted as the company’s co-founder, CEO, and “vision director,” among other titles.

The facts of the coin offering and the alleged fraud do not bear repeating here. More interesting from my perspective is how the SEC has built up its claim that ICOBox was acting as an unregistered broker-dealer:

The token sale conducted by at least one of these clients, Paragon Coin, Inc. (“Paragon”), constituted a securities offering under Howey… By actively soliciting and attracting investors to ICOBox’s clients’securities offerings in exchange for transaction-based compensation without registering as or associating with a registered broker-dealer, Defendants engaged in unregistered broker activities that violated the federal securities laws.

SEC v. Paragon Coin, we may remember, was the first major settlement announced between the SEC and an ICO issuer, back in November 2018. Around the same time, the SEC announced settlements with AirFox (unregistered securities offering) and the founder of EtherDelta (for operating an unregistered securities exchange). About 30 days prior to that, the SEC announced its settlement with ICO Superstore, a similar business to ICOBox, for operating as an unregistered broker-dealer.

So we should not be surprised that the SEC is going after ICOBox, nor should we be surprised if the SEC decides to go after other token mills in the future. Interestingly, the SEC appears to have used the cooperation and disclosure obtained in the Paragon exercise to build the case against ICOBox:

ICOBox’s team members highlighted on social media during the offering that ICOBOX had started to work with certain clients including Paragon (referring to it as ICOBox’s “child”), but did not disclose that no ICOBox clients had yet completed any ICOs using its services.

Tl;dr? The SEC is good at a lot of things, but they’re particularly good at playing follow-the-money, and their inquiries will not end with token issuers. They will use what they learn at issuer level to move up the chain to promoters and service providers. It will be interesting to learn what is revealed as they undergo that process.

3. Enigma v. Malwarebytes: 9th Circuit says Section 230 doesn’t apply to deliberately anticompetitive conduct

If you don’t know what Section 230 of the Communications Decency Act is, start here. If you do, recall that Section 230 has two main operative provisions:

  • Section 230(c)(1), which says that publishing platforms and users of publishing platforms are not liable for content created by someone else; and
  • Section 230(c)(2), which basically says that companies can’t be sued for good-faith moderation calls, so if e.g. you’re Milo Yiannopoulos and one of your posts is moderated off of Facebook, if you sue Facebook for it, you will lose.

With regard to each of those provisions, however, these above shorthand definitions are just that, shorthand, and what they gain in comprehension for the layman they lose in terms of the stripping away of the actual, technical language they use. Section 230(c)(2) reads as follows:

No provider or user of an interactive computer service shall be held liable on account of (A) any action voluntarily taken in good faith to restrict access to or availability of material that the provider or user considers to be obscene, lewd, lascivious, filthy, excessively violent, harassing, or otherwise objectionable, whether or not such material is constitutionally protected; or (B) any action taken to enable or make available to information content providers or others the technical means to restrict access to material described in [sub-]paragraph ([A]).

The facts of Enigma v Malwarebytes are as follows.

Enigma Software Group USA, LLC, and Malwarebytes, Inc., were providers of software that helped internet users to filter unwanted content from their computers. Enigma alleged that Malwarebytes configured its software to block users from accessing Enigma’s software in order to divert Enigma’s customers.

Malwarebytes and Enigma have been direct competitors since 2008, the year of Malwarebytes’s inception. In their first eight years as competitors, neither Enigma nor Malwarebytes flagged the other’s software as threatening or unwanted. In late 2016, however, Malwarebytes revised its PUP-detection criteria to include any program that, according to Malwarebytes, users did not seem to like.

After the revision, Malwarebytes’s software immediately began flagging Enigma’s most popular programs— RegHunter and SpyHunter— as PUPs. Thereafter, anytime a user with Malwarebytes’s software tried to download those Enigma programs, the user was alerted of a security risk and, according to Enigma’s complaint, the download was prohibited[.]

As a former startup guy, don’t I know that startup competition in the software industry is a fight to the death.

Fortunately, commerce is not a free for all and there are rules and certain standards of fair dealing that companies are expected to follow as they compete. Enigma brought a number of claims under state and federal law, ranging from unfair and deceptive trade practices to a Lanham Act violation of making a “false or misleading representation of fact” regarding another person’s goods. Malwarebytes argued it was immune from the action due to the effect of Section 230(c)(2).

Malwarebytes won at first instance. The 9th Circuit reversed:

The legal question before us is whether § 230(c)(2) immunizes blocking and filtering decisions that are driven by anticompetitive animus.

In relation to which the court found:

Enigma points to Judge Fisher’s concurrence in Zango warning against an overly expansive interpretation of the provision that could lead to anticompetitive results. We heed that warning and reverse the district court’s decision that read Zango to require such an interpretation. We hold that the phrase “otherwise objectionable” does not include software that the provider finds objectionable for anticompetitive reasons…
…if a provider’s basis for objecting to and seeking to block materials is because those materials benefit a competitor, the objection would not fall within any category listed in the statute and the immunity would not apply.

Pretty clear cut ratio there.

Eric Goldman’s treatment of the subject is much more detailed than my own. I recommend it to anyone looking to read further in this case; suffice it to say that I agree with the 9th Circuit, and disagree with Goldman, in that anti-competitive conduct by large tech companies is a growing problem, it cannot have been the intention of Congress to enable unlawful anticompetitive conduct with Section 230 and, at least as far as I am concerned, the natural meaning of “otherwise objectionable,” while extremely broad, does have limits, and, much as one would have a difficult time finding a motorcycle or a plant objectionable, it is conceivable that anti-malware software that is not itself malware might fall outside of those limits.

The opening that is created here is narrow and appears to be strictly limited to anti-competitive conduct, although there is a risk this ruling could be distinguished by new categories of litigants whose user-generated content is excluded without apparent justification from online platforms. I struggle to think whence these claims might arise, given that users of online platforms customarily contract away most of their rights and acquiesce to the platform’s discretion to filter content as it pleases in accordance with their policies (as opposed to the situation in Enigma, where Enigma’s rights vis-a-vis Malwarebytes originated in statute which Enigma did not waive). This of course naturally invites the question of whether states themselves will also try to create new statutory protections for constitutionally protected opinions which, of course, is exactly the thing that Section 230 of the the Communications Decency Act was enacted to prevent. Between Enigma and the EFF’s First Amendment challenge to FOSTA/SESTA, Section 230 jurisprudence over the next few years looks to be anything but boring.

See you next week!

Not Legal Advice, 9/16/19: Crypto taxes, systemic risk in DeFi, and Section 230

Welcome back to the second installment of Not Legal Advice, my new newsletter-thing I publish every week where I discuss three (3) items of interest from the prior week in crypto or crypto-adjacent technology law.

Because it’s happened twice, now, it’s a tradition. Traditions are warm and fuzzy and wholesome. So gather ’round the fireside, little marmot friends, and let’s have a conversation about what happened last week, and why it’s relevant going forward:

  1. France won’t tax shitcoin trades (also they are going to ban Libra from Europe)
  2. A company called “Staked” creates the “Robo Advisor for Yield,” or as I like to call it, the “Risk Mega Enhancer”
  3. The Second Circuit Court of Appeals finds that Section 230 of the Communications Decency Act is, indeed, as broad as its detractors claim

1) France won’t tax shitcoin trades (also they’re going to ban Libra)

According to official pronouncements from the French economic ministry:

  • Cryptocurrency transactions aren’t going to be subject to VAT.
  • Cryptocurrency trading activity won’t give rise to a tax charge until the crypto is traded out into fiat.

Three things limit what I can say about the French rules.

First, my French is not very good.

Second, I’m not a French avocat, which in French means both “male lawyer” and “avocado.”

Third, even in the two countries (America and England) where I am an avocado, I am not a tax avocado.

It suffices to say that France’s treatment of cryptocurrency trading income and gains differs from the tax treatment in England and the U.S. The English guidance makes it clear that trading gains are either income or capital gains, depending on whether the so-called badges of trade are present. In practice, HMRC guidance tells us that it is likely that capital gains tax would apply:

Only in exceptional circumstances would HMRC expect individuals to buy and sell cryptoassets with such frequency, level of organisation and sophistication that the activity amounts to a financial trade in itself. If it is considered to be trading then Income Tax will take priority over Capital Gains Tax and will apply to profits (or losses) as it would be considered as a business.

and what constitutes a chargeable asset for Capital Gains Tax purposes?

Cryptoassets are digital and therefore intangible, but count as a ‘chargeable asset’ for Capital Gains Tax if they’re both… capable of being owned… [and] have a value that can be realised.

And what events give rise to the charge?

Individuals need to calculate their gain or loss when they dispose of their cryptoassets to find out whether they need to pay Capital Gains Tax. A ‘disposal’ is a broad concept and includes… selling cryptoassets for money[;] exchanging cryptoassets for a different type of cryptoasset[;] using cryptoassets to pay for goods or services [; and] giving away cryptoassets to another person[.]”

What about in the U.S.?

The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability…

…For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.

It’s obviously more complicated than that, but you get the general gist. Speak to a tax avocado if you have further questions.

Oh, and Americans, one of the great things about being American is that the warm, loving embrace of the United States is always with you wherever you may be on this or any other world – as all the dual-nationals I know joke, “we keep the U.S. passport as it means we have a seat on the last helicopter out.” Yes, that’s how much Americans with EU passports trust European voters.

The price you pay for that privilege is that America always taxes you on your worldwide income wheresoever you may be. So don’t think that you can move to France, offload all that premined Ether you’ve been sitting on for years into BTC and avoid the tax hit. Speak to a skeptical and conservative American tax avocado first.

Also, good on France for saying it won’t permit Libra to operate in Europe, as currently proposed.

2) Robo Adviser For Risk

The only thing I like less than DeFi is a DeFi bro.

Lately a number of offerings have sprung up offering staggering, double-digit rates of interest for cryptocurrency holders who are willing to commit their savings to crypto-first lending institutions who then claim they have profitable lending businesses on the other end of the transaction. In a low- to negative-interest-rate environment, everyone everywhere is trying to figure out where they can find yield and, accordingly, where they can make money.

The hope, the dream, is that crypto has magically solved this, has found its killer app, in the form of high yield interest-bearing accounts. From Balaji:

No offense, but I don’t buy it.

First, a number of these businesses – and there are more than one – will turn out to be Ponzi schemes. We don’t know which ones, but they’re out there.

Second, there is no such thing as a free lunch:

Third, there are those who argue that risk is not the driver of high rates and that some other black magic is at work. Let us examine this argument from the perspective of a borrower, who for present purposes we shall call Bob.

The ballad of Bob the Borrower

Sally Saver deposits 100 ETH with Lily Lender, who promises Sally Saver a 5% rate of interest on her deposit. Lily Lender now needs to get that 5%, plus enough to cover her expenses, from somewhere.

Ordinarily, that means that Lily Lender needs to make a loan to Borrower Bob at a rate of interest greater than 5%. You can’t run a lending business at a loss forever to gain marketshare and adoption unless you’re burning through venture funds to do so, as some of these businesses appear to be doing. BlockFi, e.g., has made it abundantly clear that it is taking a tech-company approach to developing a lending business:

We are OK with losing money for a while. If it was purely formulaic we probably wouldn’t have enough control to make sure it’s attractive enough to a large amount of people to hit our customer acquisition targets.

I don’t have an issue with that strategy, as long as the ledger balances out and BlockFi has enough spare VC firepower to satisfy its obligations. But we should not mistake this development, which is likely being mirrored by BlockFi’s competitors, for a fundamental change in the nature of risk. The risk hasn’t disappeared, it has simply been transferred onto the companies themselves, and they are paying for it in the form of a subsidy.

Subsidies, of course, have this pesky little problem that they eventually run out. When this happens, the risk that has been buried by them rears its head and begins to manifest itself in pricing. The likely result will be that the rates offered to savers will go down, and cost of funds will go up, and there will be a liquidity crunch among those who relied on them.

Speaking of which, who does rely on these liquidity facilities? Nobody really knows; it is this writer’s observation that crypto lending companies are extremely opaque about their lending operations, no doubt to gain an edge.

With interest rates at historic lows, however, we can probably guess that the people who are willing to pay north of 10% to borrow DAI are doing so either (a) because they have an interest in seeing Dai or related financial products succeed and are willing to absorb enormous losses to create the appearance of a thriving market, (b)  cannot obtain financing from literally any other source, or (c) in the case of over-collateralized loan protocol products like Dai, are seeking to obscure the source of their cryptocurrency wealth and are willing to absorb enormous losses to do so (by defaulting on the loan).

However, the fact remains: for every crypto loan product in existence, Bob the Borrower’s payments must be equal to or greater than Sally Saver’s returns in order for the product to be viable in the long term. 

Back to our regularly scheduled programming…

“Staked Automates the Best DeFi Returns With Launch of Robo Advisor,” trumpets CoinDesk. Staked has built a product…

Staked’s new Robo Advisor for Yield (RAY) service, which launches today, automates the process of finding high-yielding opportunities. Normally, investors have had to watch constantly and reallocate quickly to catch an enhanced DeFi return. Now they can set a smart contract to do the monitoring and allocating for them.

“This product is targeted to people who hold eth or dai and want to earn yield on it,” CEO Tim Ogilvie told CoinDesk in an interview. “If you hold ETH, you can earn more ETH. If you hold DAI, you can earn more DAI.”…

With RAY, investors can put their assets (ETH, USDC or DAI) into an asset-specific pool and the smart contract will automatically invest all or part of that pool into contracts with the best yield at any given time. For now, it will invest only on the money market Compound and with the derivatives protocols DYDX and BZX. But Staked is vetting additional smart contracts for safety and reliability.

“We’re not necessarily saying we are going to beat the market. We’re just saying you’ll get the best of what a savvy watcher would get in the market,” Ogilvie said.

“The vision we are building toward is the same level of sophistication the fixed income markets have in traditional finance,” he added.

I’m not going to lie, this is pretty cool, and offerings like it remind me of, e.g., crowdsourced or robo-offerings from companies like Betterment or eToro that have done very well.

But the reason I don’t like DeFi bros claiming they reinvented structured finance, as alluded to in my tweet above, is because I am a child of the Global Financial Crisis… and indeed I spent the first half of my career, in the throes of that crisis, working in structured finance. The great lesson of the crisis was that you cannot engineer risk out of transactions, you can only obscure it: this is the first law of conservation of risk, or as my friend Palley put it years ago, “The First Law of Lawmodynamics.”

The first law of thermodynamics says energy “cannot be created or destroyed. It can, however, be transferred from one location to another and converted to and from other forms of energy.” Maybe the same is so of liability and damages. You can’t destroy or avoid either by building a better mousetrap. You can only move it, or (arguably) move the consequences of that liability elsewhere.

There’s risk somewhere in crypto, waiting to get out. A combination of regulatory intervention and Ethereum going the way of MySpace are possible avenues. As the subprime crisis showed, even the most professional, Ivy League-educated, well-dressed “Savvy Watchers” won’t see it until it’s too late and everyone is running for the exits.

Don’t make the mistake of thinking that Staked – or any other DeFi company – is providing you with guaranteed risk-adjusted returns. They’re not, and anyone who thinks they are, had better steel themselves for a very unpleasant surprise.

rodent-3703660_1280.jpg
A marmot picture: to break up the monotony of a wall of text and get a marmot thumbnail on shared links. Distributed under the Pixabay Licence.

3) The Second Circuit Court of Appeals finds that Section 230 of the Communications Decency Act is, indeed, as broad as its detractors claim

This is more of a law nerd thing, so if you’re just here for the crypto, switch off.

Politicians hate Section 230 of the Communications Decency Act, 47 U.S. Code § 230, particularly Missouri Senator Josh Hawley. Who writes:

“With Section 230, tech companies get a sweetheart deal that no other industry enjoys: complete exemption from traditional publisher liability in exchange for providing a forum free of political censorship,” said Senator Hawley. “Unfortunately, and unsurprisingly, big tech has failed to hold up its end of the bargain.

That statement is half right. Section 230 grants a broad immunity from publisher liability for online platforms that engage in traditional publisher-like activities with regard to user-generated content. They do not have any obligation to provide that forum free from censorship; indeed, Section 230 expressly permits tech companies to engage in censorship more or less free from consequences.

Section 230 gives us two rules that are largely responsible for America’s success in building a thriving Internet economy. I explore Section 230 in detail here, but for present purposes it suffices to note that it essentially promulgates two legal rules: 

  • Platforms and users are not liable for content on their platforms that has been created by someone else (Section 230(c)(1)).
  • If a web app moderates any content off of their platform, i.e. it deletes it, and anyone sues them for doing so, the person suing the web app is going to lose (the Section 230(c)(2)).

The case is Force v. Facebook. Force brought

an action for damages against Facebook pursuant to the Antiterrorism Act (“ATA”) and related claims for having knowingly provided material support and resources to HAMAS, a notorious terrorist organization that has engaged in and continues to commit terror attacks, including the terrorist attacks that killed 29-year-old Taylor Force, 16-year-old Yaakov Naftali Fraenkel, three-month-old Chaya Zissel Braun, and 76-year-old Richard Lakin, and injured Menachem Mendel Rivkin, and the families of these terror victims.

The plaintiffs alleged:

HAMAS has recognized the tremendous utility and value of Facebook as a tool to facilitate this terrorist group’s ability to communicate, recruit members, plan and carry out attacks, and strike fear in its enemies. For years, HAMAS, its leaders, spokesmen, and members have openly maintained and used official Facebook accounts with little or no interference. Despite receiving numerous complaints and widespread media and other attention for providing its online social media platform and communications services to HAMAS, Facebook has continued to provide these resources and services to HAMAS and its affiliates.

Facebook has knowingly provided material support and resources to HAMAS in the form of Facebook’s online social network platform and communication services.

The plaintiffs provided numerous examples of anti-semitic Hamas propaganda on Facebook over a period of years in their extensive, 61-page complaint, which I will not republish here. Each plaintiff sought not less than $1 billion in damages plus attorneys’ fees.

The problem the plaintiffs faced in bringing this action is that Section 230 of the Communications Decency Act was standing in their way. Recalling the literal text of Section 230:

No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.

the burden was on the plaintiffs to demonstrate why Facebook should be treated as the publisher or speaker of Hamas’ content. The parties stipulated to the fact that Facebook was a “provider… of an interactive computer service.” The plaintiffs thus disputed:

  1. whether Facebook were “acting as the protected publisher of information” under Section 230(c)(1), i.e., it was providing some other infrastructure function that was not intended to be captured by Section 230(c)(1); and/or
  2. “whether the challenged information is provided by Hamas, or by Facebook itself,” because if Facebook is an information content provider, even in some small part (see Section 230(f)(3)), the Section 230 immunity falls away.

Facebook as protected publisher of information

At minimum, the Section 230(1) immunity is thought to apply to standard categories of speech torts such as harassment or defamation. It provides American Internet companies with a near-total defense from those claims. This is in contradistinction to the European jurisdictions such as, e.g., England, and Section 5(3) of that country’s Defamation Act 2013.

How does this work in practice? Well, let’s go back to our friend Bob Borrower from Item 2 and introduce a new character, Dan Defamer, Speech Villain Extraordinaire. Let’s also assume, arguendo, that everything that comes out of the mouth of Dan Defamer, Speech Villain Extraordinaire, isn’t protected speech according to the First Amendment.

If Dan Defamer says of Bob the Borrower, in a newspaper article, “Bob Borrower is a no-good scalliwag who does not pay his debts,” Bob the Borrower may sue Dan Defamer and the newspaper for publishing the lie (whether he will win is another matter). If, however, Dan Defamer logs on to Twitter and repeats the lie there, in the plain and ordinary meaning of the term “publisher” Twitter is a publisher as much as the newspaper is. However, it is generally understood that Twitter is not, under U.S. law, treated as the publisher of the statement and therefore is not liable for its content. Twitter is not even under a legal obligation to remove it. Dan Defamer is the speaker and it is he who is liable for the consequences of the speech.

The question presented in Force is a slightly different one, though. Rather than challenging Section 230 for speech which is itself tortious, it attempts to attack Section 230 collaterally by alleging that Facebook’s provision of an online platform, which Hamas the terrorist group then accessed, meant that Facebook itself played a role in facilitating terrorism and, accordingly, was liable to pay damages to the plaintiffs under a specific federal law which provides that victims of terrorism can seek compensation from companies that commit, or aid, abet or conspire to commit, international terrorism:

By providing its online social network platform and communications services to HAMAS, Facebook violated federal prohibitions on providing material support or resources for acts of international terrorism (18 U.S.C. § 2339A), providing material support or resources for designated foreign terrorist organizations (18 U.S.C. § 2339B), and financing acts of international terrorism (18 U.S.C. § 2339C), and committed acts of international terrorism as defined by 18 U.S.C. § 2331. Accordingly, Facebook is liable pursuant to 18 U.S.C. § 2333 and other claims to the Plaintiffs, who were injured by reason of an act of international terrorism. (Emphasis mine.)

…By participating in the commission of violations of 18 U.S.C. § 2339A that have caused the Plaintiffs to be injured in his or her person, business or property, Facebook is liable pursuant to 18 U.S.C. § 2333 for any and all damages that Plaintiffs have sustained as a result of such injuries

The relevant statute, 18 U.S.C. § 2333, reads:

Any national of the United States injured in his or her person property, or business by reason of an act of international terrorism, or his or her estate, survivors, or heirs, may sue therefor in any appropriate district court of the United States and shall recover threefold the damages he or she sustains and the cost of the suit, including attorney’s fees.

In an action under subsection (a)… for an injury arising from an act of international terrorism committed, planned, or authorized by a [designated foreign terrorist organization, i.e. Hamas]… liability may be asserted as to any person who aids and abets, by knowingly providing substantial assistance, or who conspires with the person who committed such an act of international terrorism.

But the Court rejected the plaintiffs’ reasoning, stating that:

…it is well established that Section 230(c)(1) applies not only to defamation claims, where publication is an explicit element, but also to claims where “the duty that the plaintiff alleges the defendant violated derives from the defendant’s status or conduct as a publisher or speaker.”  LeadClick, 838 F.3d at 175 (quoting Barnes v. Yahoo!, Inc., 570 F.3d 1096, 1102 (9th Cir. 2009))

Put another way, even though there is a statute which prohibits providing material support to terrorism, Facebook’s status as a publisher of user-generated content means that it benefits from Section 230’s immunity from being treated as the publisher or speaker of content provided by another information content provider. Facebook wasn’t helping Hamas produce content. Accordingly Facebook could not be found liable for hosting it.

Facebook as information content provider

If Section 230’s immunity applies to liability purportedly arising under 18 U.S.C. § 2333, the next logical step for the plaintiffs – and the argument they raised – was to try to disapply the immunity by arguing that Facebook actually helped to produce Hamas’ content.

This is sort of like a situation we’ve often seen in the Star Trek movies (in particular Star Trek II: The Wrath of Khan and Star Trek: Generations). You don’t have to blast your way through the shields if you can trick the enemy into dropping them.

In Section 230 terms, “dropping the shields” means Facebook would be doing the talking or making other affirmative and material acts that “develop” the content in issue. The plaintiffs contended:

Facebook provided “to HAMAS use of Facebook’s data centers, computer servers, storage and communication equipment, as well as a highly-developed and sophisticated algorithm that facilitates HAMAS’s ability to reach and engage an audience it could not otherwise reach as effectively,”

Which the court understood to mean:

Plaintiffs contend that Facebook’s algorithms “develop” Hamas’s content by directing such content to users who are most interested in Hamas and its terrorist activities… we have recognized that a defendant will not be considered to have developed third‐party content unless the defendant directly and “materially” contributed to what made the content itself “unlawful.”

But the court was not convinced that this was the case.

Pointing to the Ninth Circuit’s decision in Kimzey v Yelp! Inc., the court points out that the “‘material contribution test… ‘draws the line at the crucial distinction between, on the one hand, taking actions… to… display… actionable content and, on the other hand, responsibility for what makes the displayed content [itself] illegal or actionable.”

Accordingly, the court held that Facebook, in this instance, was not materially contributing to Hamas’ content; “arranging and distributing third‐party information,” the majority opined, “inherently forms ‘connections’ and ‘matches’ among speakers, content, and viewers of content, whether in interactive internet forums or in more traditional media.  That is an essential result of publishing.” i.e., Facebook was staying in its lane as an interactive computer service provider.

The court concluded:

Accepting plaintiffs’ argument would eviscerate Section 230(c)(1); a defendant interactive computer service would be ineligible for Section 230(c)(1) immunity by virtue of simply organizing and displaying content exclusively provided by third parties,”

and further that

Plaintiffs’ “matchmaking” argument would also deny immunity for the editorial decisions regarding third‐party content that interactive computer services have made since the early days of the Internet [under Section 230(c)(2)].

tl;dr?

Litigants have made many attempts, through many different means, to try to hold interactive computer service providers engaged in the publishing of third-party content but not creating that content liable as if they were a publisher.

Section 230 means what it says. The court points out that courts have properly “invoked the prophylaxis of section 230(c)(1) in connection with a wide variety of causes of action, including housing discrimination, negligence, and securities fraud and cyberstalking.” And now, the Second Circuit has affirmed that this includes liability under terrorism statutes as well.

Moment of zen

Glad to know ConsenSys reads this blog. Will have to feature them more often! 

Not Legal Advice, 9/9/19

This is Not Legal Advice.

Not Legal Advice is a new, weekly newsletter-thing I will be publishing every Monday where I discuss three (3) items of interest from the prior week in crypto or crypto-adjacent technology law.

This “newsletter” will be in public, on the blog. I will not do one by e-mail. You get enough e-mail, and I don’t want your e-mail address. So check back here manually every Monday. Or see the RSS link at the bottom of my homepage. Or don’t. Do whatever makes you happy. It’s your life.

I accidentally stabbed myself over the weekend whilst trying to pry apart frozen cheeseburgers with a very sharp knife. This led to a quick ER trip, a tetanus shot, and a Scooby-Doo themed band-aid. As a result, my left hand does not work, so this post will be short.

Down to business. This week:

  1. Binance Gets Serious
  2. The Marshall Islands: All Aboard the Lulz Boat
  3. ConsenSys Rediscovers LLCs

1. Binance Gets Serious

This early profile of Binance’s CEO in Bloomberg caught my eye when it was first published:

Zhao keeps the locations of Binance’s offices and servers secret — making it tough to determine which country has jurisdiction over the company — and he instructs employees to keep quiet about their affiliation with the exchange on social media. He said he never stays in one place for too long, living out of short-term rentals and hotels in Singapore, Taiwan and Hong Kong (where he prefers the Mandarin Oriental or the Ritz-Carlton).

Yikes. This is no way to run a business. Not that it’s slowed Binance down: despite a regulatory rebuke from Japan and being forced to withdraw from the U.S. markets in June, the overseas exchange has still grown into one of the largest exchanges on the planet, if not the largest, and last week announced the creation of a dollar-backed stablecoin in association with Paxos that obtained the blessing of NYDFS. Binance is also planning to return to U.S. markets with its own exchange in due course. 

If the Paxos scheme works, it solves a potentially very big problem for Binance. Overseas exchanges with checkered regulatory histories can have trouble getting solid access to U.S. and European banks. (Even exchanges with relatively good reputations for KYC and the like, such as Coinbase, have recently lost major banking relationships.)

Exchanges that can’t get access to USD or are relegated to the margins of the financial system have attempted numerous workarounds. These include the so-called “stablecoins.” The most prominent of these is Tether, which a number of overseas exchanges, including Binance, use to provide dollar liquidity to their markets.

I query how long Tether can last in this role, seeing as it is under investigation by the Attorney General of New York, and allegedly implicated in shadowy banking (not “shadow banking”) arrangements such as those allegedly conducted by Crypto Capital Corp in relation to which several federal indictments have come down. 

Stablecoins are, legally speaking, a nightmare. The crypto-collateralized or “algorithmic” versions of these products, when not outright Ponzi schemes, are usually structurally very flawed and doomed to fail for one reason or another. Among those that are redeemable at par for a unit of currency held in an insolvency-remote account, such as Paxos and Gemini’s (and now, apparently, Binance’s) offerings, there are some hairy aspects with current implementations around the travel rule and money transmission – particularly if the system is open and, e.g., runs on an ERC-20 that anyone can use, whether they’re KYC’d with you or not. If you want one that runs like a cryptocurrency, you’re going to create liability.

Nor is this a a problem unique to the stablecoins; it’s a regulatory failing common to the entire industry in multiple different contexts (it’s currently possible to withdraw from a Coinbase wallet direct-to-exchange, for example, without Coinbase or the exchange communicating with each other.) I can’t imagine FinCEN hasn’t noticed this, although the U.S. regulatory apparatus has been slow to make any major moves in this area. It’s still early in the stablecoin space.

Whether Binance’s new coin does what Binance needs it to do in terms of granting it access to U.S. dollar markets remains to be seen. This is a development to watch in any case.

2. The Marshall Islands: All Aboard the Lulz Boat

The “Minister In-Assistance to the President and Environment Minister” of the Marshall Islands, population 53,127, writes in CoinDesk:

Blockchain has given us the opportunity to finally acquire monetary independence in a way that reflects Marshallese values. We intend to grasp that opportunity, innovatively and responsibly.

First, the word “blockchain” when used in the singular always requires an article. “The blockchain crossed the street.” “A blockchain went to the mall.” Definite or indefinite, I don’t care.

Second, “Grasping that opportunity” means, at least in terms of what has already been made public about this scheme, launching a $30 million ICO. Flashing back to 2018, when this plan was first announced:

The government reportedly intends to use its ICO proceeds to bolster its coffers ahead of the termination of U.S. reparations payments, which amount to $30 million a year, meant to compensate islanders for the United States using site as a nuclear weapons testing ground in the 1940s and 1950s.

According to CTech, 70 percent of the funds raised will be used to offset gaps in the budget expected post-reparations. Ten percent will be devoted to sustainability projects related to climate change and green energy, and the remainder of the proceeds will be distributed to Marshallese citizens.

And who is orchestrating this scheme?

The bold plan is being spearheaded by Israeli fintech company Neema. It is the brainchild of CEO Barak Ben-Ezer who sought out sovereign nations that do not have their own currency to adopt the idea. The Marshall Islands, despite being a republic since 1982, uses the US dollar as its legal tender.

And what does Neema get from the arrangement, pray tell? Per The Conversation:

The Israeli company Neema will provide the technology and support to launch an initial coin offering (ICO) that is expected to raise $30 million, half of which Neema will keep.

Unless something major has changed from the last time this scheme crossed our desk, that means:

  • The Marshall Islands is launching its own cryptocurrency, the “SOV.”
  • The “SOV” will raise $30 million for government coffers.
  • $15 million of that will be paid to Neema, at least based on third party reviews of the scheme’s terms.
  • Note: charging $15 million for a glorified Dogecoin clone is outrageous.
  • The $15 million left-over after paying Neema will be put at the disposal of the Republic of the Marshall Islands.
  • 70% of that $15 million, or $10.5 million, will go directly into Marshallese government coffers.
  • 10%, or $1.5 million, will be allocated to sustainable energy projects.
  • 20%, or $3 million, will be distributed as a one-time welfare payment to the Marshallese people. That’s $56.46 per person.
  • The SOVs in circulation will be backed by $0 in a country that uses the U.S. dollar as legal tender.

Seems legit! I wonder what SOVs will be worth when they hit the exchanges?

Unsurprisingly, the IMF has threatened to cut the islands off if they proceed with the plan. Which the Marshall Islands shouldn’t. This plan should be abandoned and the Marshallese government should go back to the drawing board.

Marshall Islanders: if you’re reading this, you can do better.

3. ConsenSys Rediscovers LLCs

ConsenSys: everyone’s favorite inadvertently hilarious blockchain tech company. Admit it, behind the scenes, we’ve all had a giggle now and then at the stuff it puts out:

This would all be terribly funny if not for the fact that n00bs who haven’t been through the wars lack the experience to parse marketing from reality, the latter of which is that Ethereum breaks anytime anyone uses it in anything resembling production numbers for even a small app using traditional infrastructure. Ethereum is not going to scale to millions or billions of users or, if it does, it will be wholly centralized on AWS through offerings like Infura rather than being a standalone coin.

Unfortunately, unless and until Ethereum dies it’s likely that we will have to continue hearing from ConsenSys as the company has a rumored war chest in the hundreds of millions of dollars (of pre-mined Ether) which it can spend on disseminating pro-Ethereum propaganda from offices around the planet… and beyond:

Ethereum! In space!
Ethereum! In space!

Comedy gold. Nobody lives in space, and Planetary Resources doesn’t have a spaceship, but in “the months ahead” the Consensys Space Agency’s “deep space capabilities” at their secret orbital launch complex in Williamsburg will “help humanity craft new societal rule systems through automated trust.” Because when I’m on the surface of the fucking Moon, my first concern should be how my Cryptokitty- and Augur-backed multi-collateral Dai is doing on a decentralized exchange used by a few dozen bots.

Anyway. On the less-of-a-space-cadet side of CSys’ operations is a company called OpenLaw. OpenLaw is a so-called “spoke” of the “ConsenSys Mesh,” or what normal people would refer to as a “subsidiary” in the “ConsenSys AG Group” (the structure of the group is fairly opaque, so this is my best guess as to which entity is the parent).

OpenLaw is one of a handful of serious early entrants in the merger of blockchain tech and Legal Tech. Blockchains and legal make sense because verifying that things happened at certain times and in a certain order among adverse parties is more important to law practice than it is to most other disciplines.

Law practice is, however, ripe for disruption and there is a burgeoning industry aiming to do it. Early standouts in traditional-law-land include A16Z-funded Atrium and the mobile app DoNotPayLaw (which claims to be a “robot lawyer” while being owned by non-lawyers and not actually being a law firm… yikes). From blockchain-land, we have CSys’ OpenLaw, Peter Hunn’s Clause, which appears to be more or less a direct competitor to OpenLaw, and Monax, which I used to work for, which was initially an enterprise blockchain firm (indeed, it was the first) but now seems aimed more at on legal process management SaaS.

OpenLaw recently announced an offering called the “LAO.” “LAO” is shorthand for “Limited Liability Autonomous Organization. This is a play on the term “Decentralized Autonomous Organization” or “DAO.”

What’s a DAO, I hear you ask? Well, neo-cypherpunks have long wanted to rid themselves of corporations. They think one can achieve this with code and write software to this end. Because decentralization-uber-alles types are, most of the time, unfamiliar with the desirability and consequences of selecting a legally recognized form of incorporation, “DAOs” that do not follow a well-worn organizational form run the risk of having their legal classification chosen for them by a court or a regulator in the event of a dispute, such as an unincorporated association or a partnership.

It makes sense to organize as a corporation and use software to manage that corporation, as many corporations currently do. Letting the software or “decentralization principles” rather than legal reality dictate the corporate form, as many decentralization evangelists would prefer, is to put the cart before the horse.

A “LAO,” we are told, solves this. The issue is that the “LAO” launch announcement is in fact a proposal to incorporate and provide services for a LLC. They are one and the same, as I explain at length in this blog post.

Strangely, however, the LAO announcement did not contain the term “LLC.” I believe the reason for this is that the use of the name “LAO” makes what would otherwise be a fairly ho-hum Delaware LLC incorporation and corporate services business, like LegalZoom or Wolters Kluwer, seem more cutting-edge than it actually is.

tl;dr: the term “LAO” is branding woo-woo. It has no legal meaning. It’s just an “LLC that buys stuff from ConsenSys.” I pray to the One True Roman Catholic God that we are not forced to endure months or years of panel talks and crypto news articles about this fatuous acronym. Indeed, I hope to never hear or see it again as long as I live.

ED06KXoX4AU7MEo
Not a ferret

Until next week!