Gordon et al v. Dailey et al

Filing 98

OPINION. Signed by Judge Joseph H. Rodriguez on 6/20/2016. (TH, )

UNITED STATES DISTRICT COURT
DISTRICT OF NEW JERSEY
BRANDON GORDON, et al.,
Plaintiffs,
v.

:

Hon. Joseph H. Rodriguez

:

Civil Action No. 14-7495

:

ZACHARY DAILEY and LAB RAT
DATA PROCESSING, LLC,
Defendants.

OPINION

:
:

This matter is before the Court on Defendants’ Motion to Dismiss Plaintiffs’
Amended Complaint in its entirety pursuant to Fed. R. Civ. P. 12(b)(6) for failure to
state a claim [Doc. 28 / 82].
The Amended Complaint asserts eight counts: (1) violation of 17 C.F.R. §
240.10(b)(5) (federal securities fraud); (2) violation of New Jersey Uniform Securities
Law; (3) violation of Florida Securities and Investor Protection Act (asserted by Plaintiff
Gordon only); (4) common law fraud; (5) negligent misrepresentation; (6) fraudulent
inducement; (7) breach of contract; and (8) unjust enrichment.
The Amended Complaint asserts that this Court’s jurisdiction rests on 28 U.S.C.
§§ 1331 (federal question) and 1332 (diversity of citizenship).
Upon review of the Amended Complaint, the Court is not satisfied that it has
subject matter jurisdiction.
This suit involves Bitcoin transactions. The Amended Complaint, however, does
not explain what Bitcoins are, beyond the allegations that Bitcoins are some form of

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virtual currency. Extrinsic sources were consulted to understand what Bitcoins are, and
how they function. 1
It is alleged that Defendant Dailey, through his LLC, “operating under the trade
name LabRatMining” 2 “min[ed] for Bitcoins”-- or at least stated that it mined, or would
mine, for Bitcoins. (Amend. Compl. Ex. 1)
According to the Amended Complaint, in early July, 2013, LabRatMining
formally announced on the Internet the following, in relevant part:
LabRatMining is a company that will be operating as a mid to large scale
miner of Bitcoins paying out dividends/returns to bondholders. Each bond
in the company represents a portion of the overall hashrate 3 owned and
managed by LabRatMining. . . .
Bond Structure—It is intended 100,000 bonds will be sold during the IPO.
These bonds represent the hashrate that these machines produce rather
than the hardware themselves. . . .
Dividends/Bond Value—Each bond will receive a minimum of 100MH/s*
worth of mining profit in dividends/returns (all dividends are contractual
returns based on investments and may simply be referred to as dividends
for future purposes) on a weekly basis. . . .
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“Bitcoin, one of the most known of virtual currencies, is an emerging technology field
defined by the European Central Bank as ‘unregulated, digital money, which is issued
and usually controlled by its developers, and used and accepted among members of a
specific virtual community.’ Unlike the U.S. dollar, Bitcoins have no physical form, they
are simply computer code stored in a digital wallet. Users can send and receive Bitcoins
in a few seconds from virtually any electronic device. Bitcoins are not legal tender, nor
backed by any government or legal entity. Like the U.S. dollar, Bitcoins have no
intrinsic value and are not redeemable for other commodities. Instead the value of
Bitcoins is due to user’s willingness to accept them as a method of payment. At the time
of publication, they are valued at around US $ 400 per Bitcoin. They can be subdivided
and spent down to one-hundred-millionth of their total value.” Hon. Jeffrey Davis,
What Bitcoins Are and Why Lawyers Should Care About Them, 40 Alaska Bar Rag 6,
Jan. / March 2016.
2

Defendant Lab Rat Data Processing, LLC, has filed for bankruptcy protection and has
been administratively terminated as a Defendant to this suit.
3

The Amended Complaint does not define or explain “hashrate.”
2

...
LabRatMining is offering bonds at far less cost to bondholders than almost
all, if not all[,] bond issuers. Some are issuing bonds at 7+BTC/GH/s
whereas these bonds are being offered initially between 1 and 2 BTC/GH/s. 4
...
• The bonds discussed above do not represent traditional bonds, but
what are commonly known as PMB’s or Perpetual Mining Bonds. Another
commonly used term is Mining Contracts. These bonds are not traditional
bonds as offered by publicly traded companies. PMB’s are actually private
contracts with anticipated returns based on investments into the company.
...
• This is a privately held, nonpublicly traded company. This company
and the PMB’s being offered are not regulated by any governmental entities
including the SEC or any other agency or board.
(Amend. Compl. Ex. 1)
Nine days later, LabRatMining, in another Internet post, elaborated on the price
of the bonds: “100,000 bonds will be made available to the public. The bonds will be
tiered in value beginning at 0.15BTC/bond with each consecutive 20,000 being 0.01BTC
higher. . . . These prices are first come first serve, and the prices are not guaranteed to
any individual purchaser.” (Amend. Compl. Ex. 2)
The post further stated: “Bitcoin Disclaimer: These bonds are being purchased in
Bitcoin, and all dividends are paid in Bitcoin. The purchaser understands what Bitcoins
are and that they are not guaranteed to maintain any future value or even any value at
all. LabRatMining does not guarantee any such values, nor does it guarantee the future
success or stability of Bitcoins. These bonds are totally dependent upon the value of

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The Amended Complaint abbreviates Bitcoin as BTC. It is not clear what “BTC/GH/s”
means.
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Bitcoins and are not otherwise secured by any asset of the company or the company
itself.” (Amend. Comp. Ex. 2)
All twelve Plaintiffs are alleged to have “purchased” bonds. Based on the above,
the Court presumes all transactions occurred in Bitcoins. The Amended Complaint does
not allege the price each Plaintiff paid, only the number of bonds purchased:

Plaintiff

Number of Bonds

Gordon

1669 5

Green

1581

Vondrak

1124

Lobb

674.333

McDonald

456

Piper

95

Galido

701

Boehler

500

Fisher-Levine

2862

Flachsbart

114

Kolonusz

2000

Henderson

4427

(Amend. Compl. ¶¶ 29, 31, 33, 35, 37, 39, 41, 43, 45, 47, 49, 51)
The Amended Complaint does not state whether Defendants ever paid any
Plaintiff “dividends” as promised.

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Plaintiff Gordon is also alleged to have “pledged” 60 Bitcoins “in return for” 600
“bonds in the company.” (Amend. Compl. ¶29, Exs. 5-6)
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Plaintiffs have demanded that Defendants “rescind the unlawful transactions at
issue and to return the monies that Defendants fraudulently obtained from Plaintiffs”
(Amend. Compl. ¶ 56), but Defendants have refused.

Subject Matter Jurisdiction Standard
“[F]ederal courts have an ever-present obligation to satisfy themselves of their
subject matter jurisdiction and to decide the issue sua sponte.” Liberty Mut. Ins. Co. v.
Ward Trucking Corp., 48 F.3d 742, 750 (3d Cir. 1995), see also Fed. R. Civ. P. 12(h)(3)
(“whenever it appears by suggestion of the parties or otherwise that the court lacks
jurisdiction of the subject matter, the court shall dismiss the action.”) (emphasis added);
Nesbit v. Gears Unlimited, Inc., 347 F.3d 72, 77 (3d Cir. 2003) (“First, because subject
matter jurisdiction is non-waivable, courts have an independent obligation to satisfy
themselves of jurisdiction if it is in doubt. See Mt. Healthy City Sch. Dist. Bd. of Educ. v.
Doyle, 429 U.S. 274, 278 (1977). A necessary corollary is that the court can raise sua
sponte subject-matter jurisdiction concerns.”).
“A party who invokes the jurisdiction of the federal courts has the burden of
demonstrating the court’s jurisdiction.” Columbia Gas Transmission Corp. v. Tarbuck,
62 F.3d 538, 541 (3d Cir. 1995) (citing McNutt v. General Motors Acceptance Corp., 298
U.S. 178, 189 (1936)).
The lack of clarity of essential facts requires the review of the Amended
Complaint to determine whether the Court has jurisdiction under 28 U.S.C. § 1331
(federal question) and or 28 U.S.C. § 1332 (diversity of citizenship).

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Federal Question
The federal question statute provides, “[t]he district courts shall have original
jurisdiction of all civil actions arising under the Constitution, laws or treaties of the
United States.” 28 U.S.C. § 1331.
The issue is whether Count One of the Amended Complaint (the only purported
federal claim) “arise[s] under” the federal securities laws—that is, are the alleged
“bonds” in LabRatMining “securities”?
In conclusory fashion, Plaintiffs assert that they are, see, e.g., Amended
Complaint, ¶ 52(c) (“the bonds issued by LRM constituted ‘securities’ as defined by the
Securities Act of 1933”), but the facts alleged seem to suggest otherwise.
First, Defendants allegedly represented that: (1) the bonds were not regulated by
the SEC; and (2) a lawyer had advised Defendants as such. While the Amended
Complaint states in conclusory fashion that (1) was false, the Amended Complaint does
not explain how it was false. That is, the Amended Complaint fails to set forth the
SEC’s legal authority to regulate the “bonds” Defendants allegedly offered for sale.
Moreover, it does not appear that the “bonds” Defendants allegedly sold were
“bonds” as that term is traditionally used in the securities laws (i.e., debt obligations).
Indeed, Defendants stated, “[t]he bonds . . . do not represent traditional bonds, but what
are commonly known as PMB’s or Perpetual Mining Bonds. Another commonly used
term is Mining Contracts. These bonds are not traditional bonds as offered by publicly
traded companies. PMB’s are actually private contracts with anticipated returns based
on investments into the company.” (Amend. Compl. Ex. 1, 2)
Thus, it is not at all clear whether the “bonds” Defendants allegedly sold were-- as
a legal matter-- bonds, stocks, or something else entirely. See generally, Rossi v.
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Quarmley, 604 F. App’x 171, 173 (3d Cir. 2015) (“Section 2(1) of the Securities Act of
1933 defines ‘security’ and includes several catch-all types of securities, including
‘investment contract[s].’ . . . An investment contract is ‘a contract, transaction or scheme
whereby a person invests his money in a common enterprise and is led to expect profits
solely from the efforts of the promoter or a third party.’ SEC v. W.J. Howey Co., 328 U.S.
293, 298—99 (1946).”).
As a result, the Amended Complaint does not adequately plead facts supporting a
conclusion that this Court has federal question jurisdiction pursuant to 28 U.S.C. § 1331.

Diversity of Citizenship—Amount in Controversy
The diversity statute provides, in relevant part, “[t]he district court shall have
original jurisdiction of all civil actions where the matter in controversy exceeds the sum
or value of $75,000, exclusive of interest and costs.” 28 U.S.C. § 1332. 6
The Court has no way of determining whether the matter in controversy exceeds
$75,000 because the Amended Complaint does not allege a dollar value associated with
a Bitcoin at any given time, much less during the relevant period(s) of time.
Basically, the Amended Complaint does not allege how many Bitcoins each
Plaintiff paid for the bonds; or whether, consistent with Defendants’ alleged promise,
Defendants ever paid any Plaintiff weekly “dividends.”
Thus, the Amended Complaint fails to allege sufficient facts which are essential
for this Court to be satisfied that the amount in controversy requirement has been met.

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The Amended Complaint sufficiently alleges complete diversity of citizenship;
Defendants are alleged to be New Jersey citizens (Amend. Compl. ¶¶ 14-15), and none of
the Plaintiffs are alleged to be New Jersey citizens (Amend. Compl. ¶¶ 2-13).
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Conclusion
For the reasons stated above, the Motion to Dismiss will be dismissed without
prejudice, and Plaintiffs will be ordered to show cause why this case should not be
dismissed for lack of subject matter jurisdiction. An Order accompanies this Opinion.

Dated: June 20, 2016

_s/ Joseph H. Rodriguez __
Joseph H. Rodriguez, U.S.D.J.

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