Here's the latest sign that the massively fraudulent ICO market is headed for a collapse.
Tezos’s investors are still waiting to learn when they can expect to receive the digital tokens that they paid a premium for during the company’s record-setting crowdsale. But as reports of abuse, internal strife and outright embezzlement have surfaced in the press, three groups of angry investors have filed class action lawsuits accusing the company of fraud and securities violations.
In response, Arthur and Kathleen Breitman, the young couple that founded the Tezos project, are asking the Switzerland-based Tezos Foundation to foot the bill for their legal defense – a controversial move, seeing as that money is supposed to seed the Tezos coin ecosystem, according to Reuters.
Tezos set a new sales record in the white-hot IPO market this summer when it raised more than $230 million in a hotly anticipated ICO that saw several behemoth firms in the northern California venture capital scene invest millions while thousands of individual investors followed suit, enticed by the astronomical returns of digital currencies like bitcoin and ethereum?
However, anybody who stopped to scrutinize the Tezos whitepaper – where the company’s founder laid out his “vision” for a product that he has yet to build – would recognize that the company’s business plan sounds like gibberish.
Despite this, the company raised more than $200 million during the first week of its July crowdsale.
To help shore up investors’ faith in the company, the leaders of Tezos promised to entrust the money they raised during the token sale to a nonprofit organization set up in Switzerland. The Tezos Foundation, is supposed to keep the company on budget until the product is finished. The company initially promised investors that it would deliver their tokens – informally known as Tezzies – by the end of the year.
The Tezos project and its founders, Arthur and Kathleen Breitman, are facing three class-action lawsuits in the United States. Plaintiffs allege federal securities law violations and that the fundraiser defrauded participants, who were told they were making non-refundable donations to the Swiss foundation. The lawsuits are seeking refunds and damages.
The project has yet to launch, which is required for contributors to receive new Tezos digital coins, called Tezzies. Meanwhile, their contributions – made in bitcoins and ether – have soared in value.Both lawsuits name as defendants the project’s young founders, their Delaware-based company, Dynamic Ledger Solutions Inc (DLS), which owns the Tezos source code, as well as the Zug-based Tezos Foundation.
A Reuters investigation in October found that the couple was in a bitter dispute with Johann Gevers, the foundation’s president, over control of the project.
Arthur Breitman told Reuters in Zurich on Thursday that he would not answer any questions. Gevers said he could not comment on the Breitmans’ request that the foundation indemnify them against legal actions.
According to legal experts who are familiar with the arcane rules governing Swiss nonprofits say the legal argument for the Tezos Foundation covering its founders’ litigation expenses is flimsy, at best.
Georg von Schnurbein, co-author of a book on Swiss foundation governance, said he saw no reason for the Tezos Foundation to cover the Breitmans’ legal costs.
“In my opinion, there is no reason for that because their activities were connected to their Delaware company, not to the foundation,” he said.
The foundation’s three board members could be held liable by Swiss regulators if they were to agree “because the lawsuits have nothing to do with the foundation purpose, only with the collection of money prior to that,” von Schnurbein added.
Unfortunately for investors, Tezos neglected to disclose many of the details about the relationship between the foundation and Dynamic Ledger Solutions Inc, Tezos’s corporate entity.
Further complicating matters is the contractual agreement between DLS and the foundation that was signed in June. The agreement, which is not public, governs the sale of DLS and its intellectual property to the foundation.
The agreement, a copy of which was reviewed by Reuters, states that the Swiss federal supervisory authority for foundations must approve the agreement. It also indicates the approval was required before the fundraiser took place.
However, a spokesman for the department that oversees the Swiss authority told Reuters that approving these types of agreements lies outside the authority’s scope of influence: “It is not the Foundation Authority’s task nor its responsibility to approve private law agreements."
The contract also says that some Tezos software code would be put in the public domain prior to the fundraiser. But the foundation later said that it has a license to release the code and will do so “at an appropriate time before the launch of the main network.” Conveniently, documents provided to investors didn’t mention the required approval by the Swiss authority or the timing of the source code’s release.
Stephen Palley, an attorney at Anderson Kill in Washington who focuses on software development, told Reuters after reviewing the investor agreement that it may help plaintiffs’ lawyers show that contributors to the Tezos fundraiser were purchasing securities, not making donations. According to the agreement, the contributions were needed to launch the Tezos network, he said. Over the summer, the SEC issued a ruling in an inquiry into the implosion of the DAO that effectively deemed all ICOs securities offerings. This means companies that launch ICOs must register their tokens as securities and abide by all pertinent securities laws.
“This weakens the argument that tokens were a discretionary gift, akin to a tote bag given to people who donate to a public radio fundraising drive,” he said.
Kathleen Breitman told Reuters in June that participating in the Tezos fundraiser was like making a donation to a public broadcaster and receiving a tote bag.
The agreement was signed on June 27 by Gevers and DLS’s shareholders, who are the Breitmans and an investment firm founded by Silicon Valley venture capitalist Tim Draper. The shareholders eventually stand to receive 8.5 percent of the funds raised in the initial coin offering in cash, and additional Tezos coins distributed over four years.
Reuters also reviewed a separate agreement between DLS and the foundation. It lists 11 early backers of Tezos, including the living trust of Frederick Ernest Ehrsam III, a co-founder of Coinbase, which operates a U.S. cryptocurrency exchange; Meta Stable Capital and CoinFund LLC.
Jake Brukhman, CoinFund’s managing partner, said the fund initially backed the Tezos project but received a refund in May before the fundraiser. “Our teams came to a mutual decision to part ways,” he said.
Ehrsam declined to comment through a spokesperson for Coinbase. Other early backers did not respond to requests for comment.
The internal strife at Tezos spilled into public view back in October when the Breitmans accused Johann Gevers, the head of a Swiss foundation which oversees their funds, of attempting to overpay himself using the massive pot of investor capital – despite the fact that the company will likely blow through its promised deadline of allocating tokens to buyers by December (the tokens have yet to be created). The news sent Tezos futures contracts trading on BitMEX spiraling lower.
Of course, Tezos isn’t the only major ICO that’s in trouble: Last month, we reported that Bancor, the world’s fifth-largest ICO by funds raised, has plunged by more than 50% since the company’s June ICO as investors have become disillusioned with its obscure product.
The question remains: Would Tezos’s failure help pacify the investing fervor surrounding ICOs? Or will investors in these products continue to be victimized by fraudsters until the offerings are banned outright?
Luckily for Tezos, if the owners can't remedy the company's many intractable problems, PwC is now accepting payment in bitcoin for its consulting services…