KDH Consulting Group LLC v. Iterative Capital Management L.P.

Background

KDH became a limited partner in Iterative Capital, L.P. in January 2018 and invested $1,000,000. KDH’s investment was governed by a subscription agreement, a limited partnership agreement, and a private placement memorandum. KDH alleged that the defendants induced the investment by representing that the fund would primarily purchase and hold cryptocurrencies, that mining would be only a limited part of the strategy, and that the fund had a successful history. KDH alleged that the defendants instead already intended to use investor money for highly illiquid mining operations.

KDH also alleged that, after the cryptocurrency market declined, the defendants made statements encouraging it not to withdraw. KDH claimed that the defendants then shifted the fund toward mining, spent $6.5 million on mining equipment, restricted withdrawals, and later converted the fund structure. In May 2020, the defendants allegedly removed KDH from the partnership and returned $126,352.42 and unvalued mining equipment.

The amended complaint contained two counts. Count One alleged that all defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 through material misstatements and omissions. Count Two alleged that the individual defendants were controlling persons liable under Section 20(a) of the Exchange Act.

Motion and Legal Standards

The court treated the parties’ premotion letters as the defendants’ motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), which asks whether the complaint states a legally sufficient claim. At this stage, the court accepted well-pleaded factual allegations as true, drew reasonable inferences for KDH, and assessed whether the claims were legally plausible rather than weighing evidence.

Because KDH alleged securities fraud, its complaint also had to meet heightened requirements under Rule 9(b) and the Private Securities Litigation Reform Act. It had to identify the allegedly misleading statements or omissions, explain why they were misleading, and plead particularized facts supporting the required mental state.

Count One: Section 10(b) and Rule 10b-5

The court held that KDH sufficiently pleaded securities fraud concerning its initial investment. KDH alleged that the defendants represented that cryptocurrency mining was an ancillary strategy and that the fund would primarily purchase and hold cryptocurrencies, while allegedly planning to make mining the primary strategy. The court found these allegations sufficient at the pleading stage to allege material misstatements or omissions, the defendants’ required mental state, reliance, and an injury connected to the purchase of securities.

The court rejected the argument that disclaimers in the offering documents automatically defeated reasonable reliance. Although the documents contained language giving the fund managers discretion to change investments and warning that assets could become illiquid, the court found tension between those provisions and KDH’s allegation that the defendants had already decided to pursue mining before KDH invested. The reasonableness of reliance was fact-intensive and could not be resolved against KDH as a matter of law on a motion to dismiss.

The court agreed, however, that statements made after KDH’s January 2018 investment could not support the Section 10(b) claim. Statements inducing an investor to keep or retain an investment, rather than to buy or sell it, are not actionable under Section 10(b). The court also rejected KDH’s argument that the later restructuring qualified as a legally recognized “forced sale.” The alleged shift toward mining was not a fundamental change comparable to a major corporate restructuring such as a merger, and KDH had not adequately alleged that a misleading statement caused the restructuring.

The order therefore dismissed with prejudice Count One only to the extent it relied on misstatements that postdated KDH’s January 2018 investment. The claim remained in the case insofar as it concerned KDH’s initial investment.

Count Two: Section 20(a)

The court declined to dismiss the Section 20(a) claim against the individual defendants. Because KDH had adequately pleaded a primary securities-fraud claim, the defendants could not defeat Count Two solely by arguing that Count One failed.

Although some allegations supporting Count Two concerned post-investment statements that could not support Section 10(b) liability, KDH also alleged that the individual defendants knew before the fundraising that cryptocurrency trading was no longer viable, knew that prior investors had been returned their money, and failed to disclose those facts. Taking those allegations as true, the court found that KDH had sufficiently alleged the individual defendants’ culpable participation for purposes of Section 20(a).

Claims Against Iterative OTC and Iterative Mining

The court dismissed the claims against Iterative OTC, LLC and Iterative Mining, LLC. KDH did not allege that either entity made the challenged misstatements, and the statements made by other defendants could not be attributed to them on the allegations presented.

The court also rejected KDH’s reliance on the “group pleading” doctrine, which can sometimes allow statements to be attributed to closely involved corporate insiders or entities. The amended complaint did not allege that Iterative OTC or Iterative Mining were corporate insiders of Iterative Capital or Iterative Capital Management, or that either entity played an essential role in operating those entities. The offering memorandum identified Iterative Capital and Iterative Capital Management as its preparers, and the complaint did not provide a basis for treating the memorandum as statements made on behalf of Iterative OTC or Iterative Mining.

Disposition

The court ordered that the motion to dismiss was DENIED IN PART and GRANTED IN PART. Count One was DISMISSED IN PART, with prejudice, only insofar as it relied on misstatements postdating KDH’s January 2018 investment. All claims against Iterative OTC, LLC and Iterative Mining, LLC were DISMISSED. The initial-investment portion of Count One and Count Two against the individual defendants were not dismissed.