it is unfair to fail to disclose paid promotion/for influencers not to do due diligence on what they promote

In Re Ethereummax Investor Litig., No. CV 22-00163-MWF (SKx), 2023 WL 6787827 (C.D. Cal. Jun. 6, 2023)

EMAX is a cryptocurrency project centered around the EthereumMax, which can be traded, spent, or otherwise transacted between token holders. EMAX Tokens were sold on decentralized exchanges, which require users to pay potentially significant “gas fees” in order to process the transaction on the Ethereum blockchain. They were launched without a “whitepaper”—a roadmap for growth/success. Subsequently, however, EMAX did release a whitepaper in October 2021, which explained the business model for EMAX, and which plaintiffs alleged revealed that EMAX’s “entire business model relies on using constant marketing and promotional activities, often from ‘trusted’ celebrities, to dupe potential investors into trusting the financial opportunities available with EMAX Tokens.” This was, they alleged, a pump and dump scheme.

This is one of two opinions—the next revisiting this one, which dismisses some claims but allows others. I’ll focus, as usual, on the false advertising bits and ignore the securities law parts. Initially, the court denied the motion to dismiss consumer protection law claims simply because the complaint also alleged violation of state securities laws and consumer protection laws don’t cover securities. “Given the issue of whether the Tokens are a “security” is a genuinely unanswered legal question, it would be unfair (and contrary to Rule 8) to prohibit alternative pleading at this stage of the litigation.” Plus plaintiffs properly articulated a theory of harm, including a price premium theory. And plaintiffs’ claims involved affirmative misrepresentations, so influencers like Kim Kardashian didn’t need to have knowledge of the falsity. By contrast, statements of “belief” in future growth were classic puffery. And claims based on Floyd Mayweather’s failure to disclose he was paid to promote EMAX tokens were dismissed because plaintiffs failed to show he had a duty to disclose.

Previously, the court rejected RICO claims in part because the court read the first version of the complaint to claim that the price was the result of celebrity endorsements that increased the popularity of the Tokens. “That market participants were willing to (and that Plaintiffs in fact did) pay more because celebrities were connected to the Tokens did not appear to the Court to be a concrete loss sufficient to establish a RICO ‘injury.’” But the amended complaint added a lot more detail, making it plausible that the price was distorted or manipulated, not just a real result of celebrity glamor spillover.

For example, defendants allegedly promoted the ability to use EMAX Tokens for purchases in nightclubs like Club LIV and Story, and their price “dropped sharply on the news that EMAX Tokens would not be available for payment at Club LIV as promised.” “If Plaintiffs can prove that objectively reasonable people are willing to pay more for cryptocurrencies that can be used at venues in the real world than they are willing to pay for Tokens that cannot be so used, Plaintiffs may be able to prove that they paid more for EMAX Tokens than the fair market value.”

Although Kardashian primarily made these claims for use at nightclubs, “presumably” the corporate executive defendants could be jointly liable on a showing that this was done on their/the company’s behalf.

Another theory of harm came from allegations that the executive defendants and some of the promoter/influencer defendants were selling off their tokens as they promoted them, engaging in market manipulation. Difficulties quantifying the amount weren’t dispositive at this stage. They adequately alleged that the price rose when the tokens were promoted and then fell based on the undisclosed and allegedly unfair selling activities of the insider defendants who possessed massive amounts of free tokens. However, plaintiffs would ultimately bear the burden of showing that the alleged unfair conduct caused their losses, which would require them to isolate the price increases attributable to specific wrongdoing by specific defendants. Defendants noted that the price of the tokens was already increasing three days before one of Kardashian’s post, and went down right after both of her posts, which they argued meant there was no price premium. Although the court agreed that volatility and other factors could make proof difficult, it pointed out that this scenario was also consistent with a story that “the insiders were accumulating Tokens prior to the impending posts, causing the price to rise, and then selling off immediately after the posts, causing the price to plummet – leaving those who bought in reliance on the post with losses and providing the insiders, who sold off in tandem with the posts, a profit.”

Did plaintiffs plead that legal remedies were inadequate? It was quite possible that they’d lack an adequate legal remedy if CLRA claims are inapplicable to intangible goods and the tokens are also not securities; this was enough for unjust enrichment. “However, the Court emphasizes that legal remedies must actually be unavailable or inadequate for Plaintiffs to eventually recover on the equitable claims. Therefore, abandoning the securities claim simply because the equitable claims appear to be easier to obtain will not be a viable option.” Also, the plaintiffs didn’t even try to specify inadequacy as to unjust enrichment, so that claim was kicked out, but the court declined to dismiss UCL/FAL claims on this ground. Plaintiffs were plausibly eligible for restitution under the UCL/FAL. There was no privity requirement as long as the plaintiffs had an interest in the money and proof that the defendant “may” have acquired a benefit from an unfair practice.

Kardashian’s posts:

first post, touting usability at nightclubs

One post indicated that Club LIV and Story were “now accepting” EMAX Tokens “for all table reservations and bookings.” This statement was plausibly false when made. And knowledge of the falsity is not required for an affirmative misrepresentation. The FAL explicitly provides that plaintiffs can recover for advertisements that were “known, or which by the exercise of reasonable care should be known, to be untrue or misleading.” “With the ‘exercise of reasonable care,’ (i.e., simply confirming the truth of the statement with the people on behalf of whom she was promoting), Kardashian should have known that Club LIV lacked the immediate ability to accept the Tokens at the time of the May Post.”

More generally, the court reasoned: “As a paid spokesperson, a celebrity endorser stands in the shoes of the company she is promoting, and such an endorser should be expected to take at least some steps to confirm the truth of any statement she wishes to disseminate to the public.”

Kardashian’s second post:

Ethereum Max "burned ... literally 50% of their admin wallet"

This was allegedly false/misleading because it wasn’t an organic sharing of what friends had told her, but paid promotion, and also because the content of the message created the false impression that the EMAX Tokens were scarce because it indicated that the founders had “burned” “50% of their Admin Wallet.” The first theory wasn’t convincing: “sharing what my friend just told me” would not, in this specific context, imply that she wasn’t being paid. The post included a “#AD” disclaimer “making it clear that Kardashian was being paid.” Although the hashtag was toward the bottom of the post, “given there is a banner in big and bold font stating ‘SWIPE UP’ placed below the string of hashtags, any reasonable consumer would inevitably see the hashtags before swiping up to purchase the Tokens.” Plus, “based on the Court’s common sense and experience, hashtags are a commonly used mechanism of communicating information on social media platforms and one would reasonably expect to see such an advertising disclaimer in the form of a hashtag below the substance of the post.” The explicit “not financial advice” statement also arguably made her spokesperson status clearer.

Also, it was Kim Kardashian:

Given Kardashian’s background and experiences, there is nothing to suggest that she was speaking on her own behalf, and she did not even imply that she was using or buying the Tokens herself. It is widely understood that Kardashian is paid for many of her social media posts, and therefore, it should not come as a surprise to any reasonable consumer that she was paid for the June Post given it included the “#AD” disclaimer.

But there was still potentially deceptive content: Even if 400 trillion tokens were in fact burned, plaintiffs sufficiently alleged misleadingness given that two quadrillion Tokens had been originally created:

The only possible reason that a business would pay someone to tell millions of followers that its product was rapidly being “burned” is to create an impression of scarcity, which as a matter of common sense economics, is intended to drive up demand and price. Advertising that conveys messages concerning limited supply or limited time offers are meant to create a sense of urgency and will inevitably be material to consumers who want the product or price offered. The scarcity statement in the June Post was clearly framed in a way to make the burning of 400 trillion Tokens appear to be a large number because it suggested that 50% of the entire universe of Tokens had been burned, and consumers reasonably would expect to be told if the percentage related to some metric other than the total universe of Tokens.

The court also gave weight to the allegation that at least one consumer survey found that 19% of respondents that saw the post invested in EMAX Tokens as a result.

Floyd Mayweather: The only misrepresentations/omissions directly attributable to him as potentially false advertising were statements at the “Bitcoin 2021” conference and the fact that he wore clothing with the EMAX label during widely publicized events without disclosing that he was being paid to do so. The statement “I believe there’s gonna be another cryptocurrency just as large as Bitcoin someday” made while wearing a t-shirt with “EthereumMax” emblazoned across the chest was clearly puffery.

Plaintiffs also alleged that, by wearing a shirt and boxing gear bearing the EMAX name and allowing EMAX to use his name and fame to promote EMAX in association with the Mayweather vs. Logan Paul fight, without disclosing that Mayweather was being paid to do so, Mayweather falsely led consumers to believe that he was organically interested in EMAX and that he was a key investor in the Token, as opposed to a paid celebrity endorser. This had some logic:

[C]onsumers may believe that a celebrity’s use or association with a product says something about the product if they tend to trust that celebrities’ judgment or believe the celebrity has valuable insight on a particular product’s features. That reliance alone would not give rise to a claim for false advertising. However, if the consumer is aware that the celebrity has used/worn a product, not because of its inherent benefits, but because he or she is being paid to do so, that could change the consumer’s perception of the product.

However, this was an omission theory of liability. Courts usually only find an omission fraudulent or deceptive: (1) when the defendant is in a fiduciary relationship with the plaintiff; (2) when the defendant had exclusive knowledge of material facts not known to the plaintiff; (3) when the defendant actively conceals a material fact from the plaintiff; and (4) when the defendant makes partial representations but also suppresses some material facts. But plaintiffs didn’t allege that any of these occurred.

Paul Pierce: He allegedly falsely represented that he made substantial money through EMAX investments (though much of his returns were attributable to selling the free EMAX Tokens he obtained as compensation for his promotions) and that he was committed to investing in EMAX as a long-term investment (despite the fact that he was simultaneously selling off large numbers of EMAX Tokens).

This was different from the allegations against Mayweather: “he explicitly represented that he was an actual investor in EMAX, making it even more important that he disclose his payments.” Not only that, but he also failed to disclose that his “investment” in EMAX was largely based on free Tokens given to him in exchange for his posts, rather than on his having actually paid money for them and having the tokens rise in price. This made it plausible that reasonable consumers would take away a false meaning. These were not forward-looking but claims that he had already “made more money” in “the past month” than he did in a year at ESPN, which was a specific, measurable statement of existing fact.

Pierce argued that reasonable consumers would have to know he was a paid promotor, but the court disagreed that it would be obvious to a reasonable consumer that Pierce had been paid to promote EMAX in the form of EMAX Tokens. “The difference is important because had Pierce actually invested large amounts of money in EMAX, his incentive would be aligned with other investors — namely, to ensure the price stayed high. But since he was given EMAX Tokens for free, he had much more incentive to sell the Tokens given any amount sold would produce a return.”

So too with the “long haul” statement.  “His statement was an affirmative representation of his personal investment position, which could be proven false if Plaintiffs can prove that reasonable consumers have a common understanding of what ‘long haul’ means in the relevant context.”  His trading activity lasted a total of 16 days, “and that fact alone could suggest falsity.” Three days after telling investors he was invested for the “long haul,” he sold 9.7 trillion EMAX Tokens. Materiality was a closer question, since Pierce isn’t a well-known financial advisor.

But consumers didn’t need to think of him as a sound financial advisor to rely on his statements, given his statements that he had a sizeable position worth over $2 million. It was plausible for consumers to believe that he had a large enough stake that his long-term retention would significantly impact the market price, and plaintiffs alleged that his trading activity did in fact affect the price drastically.

Other statements against the company/executives weren’t sufficiently pled as false advertising (see below for unfairness analysis). The court thought that certain things were vague puffery: the statement that “technological upgrades” were on the way for EMAX; that EMAX had secured a “landmark agreement” with the Mayweather team; that there wouldn’t be a “rug pull”; and that the founders were “looking to lock their wallets.”

UCL unfairness: California courts have different approaches to unfairness. Some require anticompetitive conduct, though that’s only mandatory for cases brought by competitors. Some balance the utility of the conduct against the alleged harm. And some apply the FTC Act standard. The court here applied the balancing test, informed by FTC test considerations.

The unfairness UCL claim against the promoter/influencer defendants seemed to be based on celebrities’ promotions of worthless investments to their loyal followings without at least vetting the Tokens and/or disclosing that they received substantial compensation for their promotions. That against the company executives as well as Mayweather and Pierce focused on allegedly knowing orchestration of a “pump-and-dump” scheme. And perhaps the executives’ conduct was unfair because they knowingly solicited investor funds with no legitimate business plan for sustainable returns.

Promoter liability: Defendants argued that there was no substantial injury, and that plaintiffs could have avoided the injury by doing better research instead of making investments based on celebrity endorsement. Plaintiffs pointed to an FTC Report noting that cryptocurrency has become “an alarmingly common method for scammers to get peoples’ money” and that since the start of 2021, more than 46,000 people have reported losing over $1 billion in crypto scams,” which is more than any other payment method.

Under the balancing test, a practice is “unfair” if the conduct is “immoral, unethical, oppressive, unscrupulous or substantially injurious to consumers” and the “utility” of the “defendant’s conduct [does not outweigh] the gravity of the harm to the alleged victim.” Plaintiffs adequately alleged uinfairness against the promoter defendants “based on the practice of touting an investment opportunity to their followers without vetting the opportunity or disclosing compensation for their endorsements.” This was at least “unscrupulous”; even as to Kardashian, it was still plausible “that the practice of touting a financial investment to her millions of loyal followers (and encouraging them to purchase), without any sound basis for believing it to be a worthwhile investment is an unscrupulous and thereby unfair practice.”

And the FTC report made it more plausible that plaintiffs acted reasonably: “it cannot be the case that the many thousands of people that have been defrauded by crypto scams are all unreasonable consumers.” It was also significant that the posts were specifically aimed at “already-dedicated followers,” who were by definition “predisposed to place significance on what the celebrities they follow are doing and saying” and “particularly vulnerable to the messages conveyed to them.” Plus, the relevant information—that the celebrities were promoting for pay instead of from an honest belief—was not disclosed anywhere by anyone, so more research wouldn’t have helped. Also, “Defendants do not offer a single countervailing benefit of allowing celebrities to endorse unvetted products without disclosing that they are being paid to do so.” The court also noted that its position was supported by the SEC’s position on the matter (the FTC thinks so too!).

The pump-and-dump scheme was also sufficiently alleged to be unfair (if not barred by securities laws). “[T]he fact that the securities laws prohibit such conduct demonstrates that the claim is tethered to legislative public policies and advances the spirit of such laws.”

The third theory—solicitation of investments promising substantial returns despite the lack of any legitimate business plan—also sufficed against the executive defendants. “The practice is certainly unscrupulous and unethical, and (as has been discussed) caused losses to at least certain consumers, leaving them with a ‘practically worthless digital asset.’” Investment promoters are in a position of trust and are expected to responsibly and in good-faith manage the funds they solicit.

Finally, injunctive relief requests were dismissed because future harm was not plausible.

 

In Re Ethereummax Investor Litig., No. CV 22-00163-MWF (SKx), 2023 WL 6787458 (C.D. Cal. Oct. 3, 2023)

After the previous decision, the plaintiffs amended the complaint one last time. I’ll only mention relevant consumer protection law changes.

The court previously granted leave to amend to articulate Mayweather’s duty to disclose the nature of his involvement to support Plaintiffs’ fraud-by-omission claims under California, Florida, New York, and New Jersey state consumer protection laws. A failure to disclose a fact can constitute actionable fraud or deceit “when the defendant has exclusive knowledge of material facts not known or reasonably accessible to the plaintiff.” And plaintiffs sufficiently alleged materiality. Mayweather didn’t identify any cases or otherwise demonstrate that the distinction between being just a paid promoter and an actual backer is categorically immaterial as a matter of law. It wasn’t just that he was a paid promoter—that was possible for consumers to know—but that he omitted the fact that he wasn’t an actual investor.

This time, the complaint sufficiently alleged that one executive, Perone, was personally involved in some of the wrongful conduct. It was not enough to allege that he controlled social media accounts by virtue of his role as CEO. But plaintiffs alleged more: that he created EMAX and the company, and was its sole director. “Based on these allegations, it is plausible that Perone actively and directly participated in the social media posts.”