Lu v. Enigma MPC, Inc.

Background

Enigma and its founders, Can Kisagun and Guy Zyskind, developed products involving encrypted-data sharing and analysis. To fund the Enigma Protocol and Catalyst, the defendants conducted an initial coin offering from June 2017 through September 11, 2017, selling ENG tokens. Bin Lu bought approximately 280,000 ENG tokens on Binance, a digital-currency exchange, for approximately $1.4 million.

In February 2020, the Securities and Exchange Commission found that Enigma had offered and sold unregistered securities in violation of the Securities Act of 1933. The SEC ordered Enigma to pay a $500,000 civil penalty and reimburse qualifying purchasers who submitted claims within the specified period.

Afterward, Kisagun and Zyskind allegedly shifted from Enigma to the Secret Network, which was associated with SCRT Labs. From February 2020 through early 2021, ENG holders could exchange ENG tokens for Secret tokens. Lu alleged that the defendants did not publicly announce the exchange opportunity or otherwise notify ENG holders, and that he did not learn about it. The defendants presented evidence that the opportunity was disclosed in Enigma’s Securities and Exchange Commission filings, on Enigma’s website, and in an announcement on Binance. Lu still owned his ENG tokens, but alleged that abandoning Enigma eliminated the market for them and made them valueless.

Claims and Standard

The complaint asserted two claims: (1) a violation of the California Consumer Legal Remedies Act (CLRA), specifically California Civil Code § 1770(a)(10), and (2) conversion. The defendants moved to dismiss under Federal Rules of Civil Procedure 9(b) and 12(b)(6). Rule 12(b)(6) permits dismissal when a complaint does not plausibly state a claim for relief. Rule 9(b) requires fraud allegations to describe the alleged misconduct with particularity, including the relevant who, what, when, where, and how.

CLRA Claim

The court granted the motion to dismiss the CLRA claim. The CLRA covers unfair or deceptive practices in transactions involving goods or services. The court concluded that Lu’s pleaded claim concerned an investment in ENG tokens, which were intangible financial products rather than goods or services covered by the CLRA. The SEC had determined that the tokens were securities, and Lu alleged that he bought them as an investment expecting their value to increase. His claim was based on the alleged loss of value after the defendants abandoned Enigma, not on a transaction for an Enigma service.

The court also gave a separate reason for dismissal. Lu relied on the CLRA provision concerning advertising goods or services with an intent not to supply reasonably expected demand. But he did not allege that ENG tokens were in short supply; he bought approximately 280,000 tokens. The court further held that the CLRA claim could not be based on the defendants’ actions years after Lu’s purchase. The court considered Lu’s opposition argument that ENG tokens could be used to participate in the Enigma Protocol, but held that this new theory did not make the pleaded claim plausible.

Conversion Claim

The court also granted the motion to dismiss the conversion claim. Conversion requires an actual interference with the plaintiff’s ownership or right to possess property, through a wrongful act inconsistent with those rights, causing damages. The court recognized that conversion can sometimes apply to intangible property, including securities, and that destroying property can sometimes qualify. It also held that Lu’s continued ownership of the ENG tokens did not by itself resolve the issue, because the relevant question was whether the defendants interfered with the intangible property rights associated with the tokens.

The court nevertheless found that Lu had not plausibly alleged wrongful conversion. The defendants’ alleged abandonment of Enigma could potentially have interfered with rights connected to the investment, but the defendants presented evidence that the token-swap opportunity and the transition to the Secret Network were disclosed publicly in multiple places, including Securities and Exchange Commission filings and Binance. In the court’s view, Lu’s failure to learn about the publicly disclosed opportunity did not plausibly show a wrongful conversion, particularly because he purchased the tokens on a secondary market and sought direct notice.

Disposition

Judge Beeler granted the motion to dismiss the CLRA claim and also granted the motion to dismiss the conversion claim. The court gave Lu leave to amend, meaning he could file an amended complaint if he had viable additional allegations. Any amended complaint had to be filed within 21 days and include a blackline comparison against the current complaint. The order resolved ECF No. 19.