In BIN LU, Plaintiff, v. ENIGMA MPC, INC., et al., Defendants. Additional Party Names: Can Kisagun, Guy Zyskind, No. 23-CV-02152-LB, 2023 WL 8360052, at *4–6 (N.D. Cal. Dec. 1, 2023), Judge Beeler dismissed a CLRA claim premised on the argument that cryptocurrency was a “tangible good” under the CLRA.  The facts were as follows:

The plaintiff resides in Singapore.  The defendants are Enigma (a corporation with a principal place of business in San Francisco), Mr. Zyskind (Enigma’s Chief Executive Officer, Chief Technology Officer, President, and Director), and Mr. Kisagun (Enigma’s Chief Product Officer). Messieurs Zyskind and Kisagun founded Enigma in 2015 “with an initial focus [on] developing technologies dedicated to securely sharing and analyzing encrypted data.”5 In 2017, they published whitepapers on the Enigma Protocol, “a privacy-focused, decentralized computation platform,” and Catalyst, “a cryptocurrency investment platform to be deployed on the Enigma Protocol.”  To raise funds for the Enigma Protocol and Catalyst, the defendants conducted an ICO from June 2017 through September 11, 2017 for a “proprietary digital currency,” ENG tokens.7 During this period, they promoted the ICO on Enigma’s website and social-media channels. They “boasted Enigma’s founders’ and advisors’ connections to institutions such as the MIT Media Lab in an effort to generate interest and participation.” They paid third parties in ENG tokens to promote the ICO in a “so-called ‘bounty campaign’ ” to “create the appearance” that ENG tokens were a good investment. The defendants raised “approximately $45 million [during the ICO] through the sale of approximately 75 million ENG [t]okens to nearly 6,000 people.” The ICO buyers sold ENG tokens on the secondary market through digital-currency exchanges such as Binance. In September 2017, the plaintiff purchased “approximately 280,000” ENG tokens on Binance for “approximately $1.4 million.” After the ICO, the SEC “instituted cease-and-desist proceedings against Enigma pursuant to Section 8 of the Securities Act of 1933.”10 In February 2020, the SEC found that through the ICO, Enigma had offered to sell and sold unregistered securities, in violation of the ’33 Act. The SEC ordered Enigma to pay a $500,000 civil penalty and  reimburse those who purchased ENG tokens and submitted claims to Enigma “within a given time period.”  Mr. Zyskind and Mr. Kisagun then allegedly “abandoned Enigma in favor of the Secret Network, a cryptocurrency project that Enigma characterized as ‘the successor of the Enigma Protocol.’ ”12 “[M]any of the same individuals who were involved with Enigma are now involved in some capacity with the Secret Network.” Mr. Zyskind is the Chief Executive Officer and Founder of Gamma Research and Development Ltd. d/b/a SCRT Labs, which “characterizes itself as ‘the driving force and the founding core development team behind Secret Network.’ ” Enigma’s online presence has been rebranded “under the guise of the Secret Network.” From February 2020 until early 2021, the Secret Network allegedly allowed ENG token holders to exchange those tokens for “Secret” tokens, which the plaintiff characterizes as the “Secret Swap.” The defendants “never publicly announced the Secret Swap or otherwise informed ENG [t]oken holders of the Secret Swap.” The plaintiff did not receive notice of the swap opportunity. After the defendants “abandoned” Enigma because of the SEC cease-and-desist action, there was no longer an active market for ENG tokens, which rendered the tokens valueless.

Judge Beeler found that the CLRA did not apply both because no tangible goods were involved and because the CLRA did not apply to post-sale conduct.

The court grants the motion to dismiss the CLRA claim because the CLRA does not apply. The CLRA makes “unlawful” certain “unfair methods of competition and unfair or deceptive acts or practices undertaken by any person in a transaction intended to result or that results in the sale or lease of goods or services to any consumer.” Cal. Civ. Code § 1770(a). “Goods” are defined as “tangible chattels bought or leased for use primarily for personal, family, or household purposes.” Id. § 1761(a). “Services” are “work, labor, and services for other than a commercial or business use, including services furnished in connection with the sale or repair of goods.” Id. § 1761(b).  The main issue is whether the CLRA applies to the ENG tokens. The defendants contend that the CLRA, which applies to services and tangible goods, does not apply to digital currencies like ENG tokens that are intangible goods, even if some “ancillary services” are provided too.  Citing Enigma’s Form 10, the plaintiff counters that the tokens were used to participate in the Enigma protocol (for example, by paying transaction fees), and thus “amount to a transaction for a service rather than an intangible good.”  The parties therefore do not dispute that the intangible ENG tokens are not goods under the CLRA. Fairbanks v. Super. Ct., 46 Cal. 4th 56, 65 (2009) (“investment securities” are “intangible goods” for purposes of the CLRA); Smith v. Ygrene Energy Fund, Inc., No. 17-cv-01258-LB, 2017 WL 3168519, at *8 (N.D. Cal. July 26, 2017) (“The California Supreme Court, and federal courts in California, have held that the CLRA does not apply to intangible financial products” such as loans); Suski v. Marden-Kane, Inc., No. 21-cv-04539-SK, 2022 WL 3974259, at *7 (N.D. Cal. Aug. 31, 2022) (“The parties agree that Dogecoin is cryptocurrency and thus is an intangible good outside the purview of the CLRA.”); Jeong v. Nexo Fin. LLC, No. 21-cv-02392-BLF, 2022 WL 174236, at *23 (N.D. Cal. Jan. 19, 2022) (“[J]ust as with an extension of credit, the underlying ‘good’ in a cryptocurrency exchange is not a ‘tangible chattel.’ ”). Instead, they dispute whether the services associated with Enigma tokens render the tokens subject to the CLRA when ordinarily, they would be intangible financial products not subject to the CLRA.   The plaintiff’s allegations are about unfair practices that affected an investment into an intangible financial good, rendering it worthless. The SEC determined that the ENG tokens are securities.29 The plaintiff bought his tokens as an investment because he “had reason to believe that the value of ENG [t]okens would increase over time.”  The tokens lost value, allegedly because the defendants abandoned Enigma and thereby eliminated the secondary market for the purchase or sale of ENG tokens. That rendered the tokens (the plaintiff’s investment) nearly worthless.  These are allegations about an intangible good, not a service. Thus, for the claim that the plaintiff pleaded, based on the cases cited in the previous paragraph, the Enigma cryptocurrency is an intangible good (and only an intangible good) that is not subject to the CLRA.  In his opposition, the plaintiff cites Enigma’s statements in its Form 10 that, he asserts, establish that the ENG tokens were tethered to a service: the Enigma Protocol was a “decentralized network for privacy-preserving computations” in which “ENG tokens were meant to be used by their holders to participate in the [Enigma] protocol by paying transaction fees (without which, no transaction can be executed on the blockchain), to take and run nodes to secure the network, to receive network incentives and fees[,] and to reward nodes for successful contribution to the network.”   The plaintiff asserts that because the tokens’ utility was participation in the protocol, they “amount to a transaction for a service rather than an intangible good.”  To support this argument, he analogizes to cases that have held — in the gaming context — that in-game transactions in digital currency are services subject to the CLRA because the users buy the in-game currency to participate in the online game, which is an entertainment service. Courts are split on the issue. Ochoa v. Zeroo Gravity Games LLC, No. CV 22-5896-GW-ASx, 2023 WL 4291650, at *13 (C.D. Cal. May 24, 2023) (recognizing split). In Doe v. Roblox Corp., for example, the court held that a virtual currency in a video game is a CLRA “service” because when players use real money to buy in-game money, that transaction is “to make use of a part of” the online-entertainment service that is the video game. 602 F. Supp. 3d 1243, 1263–64 (N.D. Cal. 2022). Other cases have reached the opposite conclusion, holding that in-game money is merely “credit extended” to players, like an intangible good. Doe v. Epic Games, Inc., 435 F. Supp. 3d 1024, 1045–46 (N.D. Cal. 2020) (collecting cases); Mai v. Supercell Oy, 648 F. Supp. 3d 1130, 1136 (N.D. Cal. 2023) (“The Court agrees with other courts in this district in holding that virtual currency is not a good or service for purposes of the CLRA.”).  Conceptually, a transaction for an intangible good perhaps could fall within the CLRA’s scope if the transaction is “intended to result or [did] result[ ]” in the sale of services to the consumer. Cal. Civ. Code § 1770(a). But here, the plaintiff invested in an intangible good that literally was a security issued by a company to raise money to fund its business. And he did so to make money if the further development of the company’s service increased the tokens’ value.  Moreover, he bought his tokens from someone other than the defendants, thus raising doubt (at least in the absence of an allegation otherwise) that his transaction was intended to result in his participation in the Enigma Protocol. The gaming cases, on the other hand, are predicated on the conclusion that users buy digital currency with real money to play the game, the entertainment service. Roblox, 602 F. Supp. 3d at 1251, 1263–64. The gaming cases thus do not change the court’s earlier analysis: the tokens are an intangible good outside the CLRA’s scope. An association of a potential service with cryptocurrency securities traded on a secondary market does not implicate the CLRA for claims predicated on (essentially) company acts that decrease the tokens’ value on the secondary market.   . . .Here, the plaintiff alleges that the defendants induced him to purchase ENG tokens “by representing that [the tokens] would contribute to the development and functionality of the Enigma Protocol and Catalyst” (which the plaintiff believed would in turn increase the tokens’ value), but then “deliberately subvert[ing] [the plaintiff’s] reasonable expectations by abandoning Enigma.” But again, at the time of the transaction, the plaintiff received everything he bargained for. The alleged abandonment came years later and “a CLRA claim cannot be based on events following a sales transaction.” Durkee v. Ford Motor Co., No. C 14-0617 PJH, 2014 WL 4352184, at *3 (N.D. Cal. Sept. 2, 2014).

Judge Beeler also found that the Defendants had not converted the cryptocurrency because they did not interfere with the plaintiff’s ownership or possession of ENG tokens.

The nature of an investment contract, then, helps define what property rights the plaintiff had by virtue of his ownership of ENG tokens. “The Ninth Circuit has distilled Howey’s definition of an investment contract into a three-part test requiring (1) an investment of money (2) in a common enterprise (3) with an expectation of profits produced by the efforts of others.” Teed, 2022 WL 16839496, at *11 (citing Warfield v. Alaniz, 569 F.3d 1015, 1020 (9th Cir. 2009)). A “common enterprise” can exist where the investment scheme involves “horizontal commonality,” which “may be established by showing that the fortunes of the investors are linked with those of the promoters.” Id. at *12 (quoting SEC v. R.G. Reynolds Enters., 952 F.2d 1125, 1130 (9th Cir. 1991)). . . These principles help narrow the issue here. For one, the fact that the plaintiff still owns his ENG tokens is not dispositive: the question instead is whether the intangible property rights associated with his tokens have been interfered with. Also, the fact that the plaintiff’s ENG tokens are now valueless is not dispositive: the plaintiff does not have a property right in the tokens’ value standing alone. BMA LLC v. HDR Glob. Trading Ltd., No. 20-cv-03345-WHO, 2021 WL 4061698, at *17 (N.D. Cal. Sept. 7, 2021) (“[T]here is no case law suggesting that a plaintiff can bring a conversion suit anytime a freely-undertaken, high-risk, high-reward investment turns out to be unsuccessful.”) (cleaned up).  Furthermore, the scenario in Growth Properties might be analogized to the present case: like Growth, the plaintiff here held intangible property (an investment security) linked to the existence of something independent of that property (Enigma’s offerings). In the language of the Howey test for an investment contract, the plaintiff’s fortunes were linked in a common enterprise with Enigma. Thus, because abandoning the Enigma project would constitute abandoning the common enterprise underlying the plaintiff’s investment contract, there conceivably could have been a conversion here.  Yet as the defendants’ argument shows, that is not the end of the analysis, because a conversion claim requires that the defendant’s “act inconsistent with the property rights of the plaintiff” be “wrongful.” In re Emery, 317 F.3d at 1069. The defendants contend that they did not engage in wrongful conduct: instead, they publicly disclosed the token-swap opportunity and what the plaintiff characterizes as their “abandonment” of the Enigma project. This gave the plaintiff the opportunity to swap his ENG tokens for Secret tokens. (In the language of the Howey test, the plaintiff had the opportunity swap his investment contract for one linked to a new (and roughly equivalent) common enterprise.) According to the defendants, the plaintiff’s failure to take that opportunity constituted implied consent to the alleged conversion, which in turn means the conversion was not wrongful.  Farrington v. A. Teichert & Son, 59 Cal. App. 2d 468, 474 (1943) (“[T]here can be no conversion where an owner either expressly or impliedly assents to or ratifies the taking, use or disposition of his property.”). The defendants contend that Farrington shows that the plaintiff impliedly consented in the present case. In Farrington, the plaintiff’s conversion claim “ar[ose] out of the removal of sand, rock and gravel from his land,” and “[t]he court reasoned that the plaintiff had consented to the removal because he had simply watched as the defendant made multiple trips to the plaintiff’s land, removing truckloads of sand, rock and gravel each time.” Bank of New York v. Fremont Gen. Corp., 523 F.3d 902, 914 (9th Cir. 2008) (describing Farrington).  The court’s decision in O’very v. Spectratek Techs., Inc. is also relevant. No. CV03-0540CBMPJWX, 2003 WL 25781232 (C.D. Cal. Aug. 7, 2003). There, the plaintiffs alleged that after receiving shares of stock in Lumens in exchange for services they provided to Lumens, the defendants “transferred all assets of Lumens to Spectratek without any consideration to Lumens” and without any notice to the plaintiffs. Id. at *4. The plaintiffs thus alleged that “the stocks were wrongfully ‘converted’ to Spectratek.” Id. The court held that the plaintiffs adequately alleged a claim for “wrongful conversion.” Id.  These cases suggest that whether the defendants’ alleged abandonment of the Enigma project in favor of the Secret Network project was a wrongful conversion could depend on whether the plaintiff had adequate notice of the opportunity to swap his ENG tokens for Secret tokens. At the pleading stage, of course, the court must draw all reasonable inferences in the plaintiff’s favor and the question is only whether it is plausible that the defendants’ conduct was wrongful. . . Under these circumstances, as the court said at the hearing, it is hard to conclude (even at the pleadings stage) that the defendants’ conduct was wrongful. The relevant facts were disclosed in multiple ways, including public SEC filings, and at the direction of the SEC. Essentially, the plaintiff — an investor through a secondary market — wants direct notice. In the context of this case, that is not a plausible claim of conversion. The court thus grants the motion to dismiss the conversion claim.