The More Things Change, the More They Stay the Same: Hong Kong Courts Adapt to the World of Bitcoin and iPhones

Cutting-edge technology provides fraudsters with new twists on old schemes. Although it often takes years for legislation and case law to directly address novel technologies, two recent Hong Kong High Court judgments provide a glimpse into how courts are applying long-standing legal concepts to the ever-evolving digital world. Given the interconnectivity of global markets, these decisions bear implications for both victims and alleged perpetrators beyond Hong Kong’s borders.

VICTIMS OF CRYPTOCURRENCY FRAUD CAN USE TRADITIONAL TOOLS TO PURSUE RECOVERY

On 1 November 2019, the Court of First Instance granted a Mareva injunction freezing assets including bitcoins. The plaintiff in the case, Nico Constantijn Antonius Samara v Stive Jean Paul Dan [2019] HKCFI 2718, alleged that he engaged the defendant to be his agent in selling bitcoins, but was defrauded.

According to the plaintiff, he transferred bitcoins to the defendant’s digital wallet on a Hong Kong-based cryptocurrency exchange. Although the defendant initially sold some of these bitcoins and remitted proceeds to the plaintiff, after a few months the defendant purportedly stopped the remittances. The plaintiff thereafter applied for, and obtained, a freezing order over assets including the bitcoins that remained accessible through the defendant’s exchange-based wallet. 

Although Samara did not explicitly address whether bitcoin is property, a recent English case did: In AA and Persons Unknown & Ors, Re Bitcoin [2019] EWHC 3556 (Comm), the English High Court recognized cryptocurrencies as property under English law, consistent with the UK Jurisdictional Taskforce’s Legal Statement on Crypto Assets and Smart Contracts (November 2019).

With this recognition, victims of digital currency fraud can now more confidently apply for injunctive relief to freeze cryptocurrency in common law jurisdictions. (Victims should, however, monitor likely appeals of the above and similar cases.) 

Victims should also understand that, contrary to popular belief, users of cryptocurrencies are not categorically anonymous and untraceable. Instead, wrongdoers are potentially identifiable because of two common features: First, cryptocurrencies utilize distributed ledger technology, with blockchain being the most famous. A fundamental aspect of distributed ledgers is that information recorded on them is immutable, which means the historical transaction sequence of any given distributed ledger-based cryptocurrency is publicly accessible and traceable.

That said, a second piece of information is still needed to tie a particular distributed ledger-based cryptocurrency transaction to an identifiable individual beyond a pseudonym.  Victims who can trace transactions to crypto-exchanges are increasingly in a better position to secure this information. Although a few years ago many of these exchanges eschewed the know-your-client (“KYC”) procedures common at centralized financial institutions — being the type of institution that many early cryptocurrency proponents sought to avoid — the current trend among reputable crypto-exchanges is to adopt appropriate KYC requirements. Consequently, victims increasingly may be able to use traditional discovery tools to seek relevant disclosures from these exchanges about potential wrongdoers.

Moreover, victims should also explore whether these tracing techniques may support a liability (as opposed to proprietary) based judgment against a wrongdoer. In this way, even if the wrongdoer has dissipated the stolen digital assets, a court may still find them liable for damages. The victim may then be able to enforce that liability judgment against disparate assets in various jurisdictions using existing cross-border judgment recognition laws.

REGULATOR ACCESS TO SMARTPHONES INCREASES DEFENDANT GLOBAL EXPOSURE

Defendants facing financial misconduct allegations are also learning that existing regulatory laws already capture life’s cutting-edge conveniences, leading to cross-border exposure for investigatory targets.

On 14 February 2020, the Court of First Instance dismissed a challenge to the Securities and Futures Commission’s (“SFC”) investigative powers in Cheung Ka Ho Cyril v. Securities and Futures Commission [2020] HKCFI 270. Among other things, the applicants who allegedly committed securities fraud challenged whether smartphones are included within the statutory definition of “records and documents”. If not, the SFC had no basis for seizing them.

Using traditional approaches towards statutory construction, the court found that digital devices such as smartphones are indeed captured by this definition. Furthermore, the court held that under section 183 of the Securities and Futures Ordinance, the SFC could compel disclosure of passwords necessary for it to open seized or produced smartphones. 

As smartphones are a gateway to a wealth of information about the user, this judgment results in a significantly scaled-up exposure unique to contemporary digital life. Theoretically, a smartphone could give an investigator wide-ranging access to an individual’s communications and personal data among other potentially valuable sources of information that, until recently, would have been preserved in disparate locations, if at all.

In practice, subject to legal professional privilege and privacy protections, the SFC will be legally limited to only seeking information relevant to its investigation or authorized under a valid warrant. The SFC can, however, share such information with foreign authorities under certain conditions, thus creating potential global exposure. This will be particularly relevant in situations where foreign authorities — who are outside the SFC’s practical control — may see the SFC’s powers as a potential workaround for getting critical information that they would otherwise have difficulty obtaining.

How a foreign regulator may use such information will depend on local laws. Therefore, to mitigate cross-border exposure, a defendant’s legal representatives must hold local and foreign regulators to the relevant information restrictions applicable to any given circumstance. This requires understanding at an early stage a defendant’s rights and protections available in all relevant jurisdictions and maintaining a unified global defence strategy.

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Whether a fraud victim or a putative defendant, it is critical to recognize how traditional legal tools can be adapted to new technology, extending one’s rights and vulnerabilities around the world. Recognizing and leveraging the applicability of these tools is a crucial step towards obtaining a favourable outcome in Hong Kong, common law jurisdictions and beyond. 

Lawyer, Kobre & Kim