NOWAK v. XAPO, INC.

Opinion

1 2 3 UNITED STATES DISTRICT COURT 4 NORTHERN DISTRICT OF CALIFORNIA 5 SAN JOSE DIVISION 6 7 DENNIS NOWAK, Case No. 5:20-cv-03643-BLF

8 Plaintiff, ORDER GRANTING DEFENDANT’S 9 v. MOTION TO DISMISS WITH LEAVE TO AMEND 10 XAPO, INC., et al., [Re: ECF 22] 11 Defendants.

12 13 Dennis Nowak (“Plaintiff”) sues Xapo, Inc., Xapo (Gibraltar) Limited, Indodax, and ten 14 unidentified John Doe defendants (collectively, “Defendants”) for hacking into his cryptocurrency 15 exchange account, stealing 500 Bitcoins, and depositing them into separate hot wallet addresses. 16 Plaintiff asserts violations of (1) California Penal Code § 496 (Possession of Stolen Property); 17 (2) Aiding and Abetting under 18 U.S.C. § 1030(a)(4) (the Computer Fraud and Abuse Act); and 18 (3) Assisting Unlawful Access to a Computer under California Penal Code § 502 et seq. (the 19 Comprehensive Computer Data Access and Fraud Act). See generally Compl., ECF 1. Xapo, Inc. 20 (“Defendant”) brings this Motion to Dismiss for failure to state a claim. See Mot. to Dismiss 21 (“Mot.”), ECF 22. The Court heard arguments for the Motion on November 12, 2020. Mot. Hr’g, 22 ECF 45. For the reasons stated on the record and discussed below, the Motion is GRANTED 23 WITH LEAVE TO AMEND. 24 I. BACKGROUND 25 A. Factual Allegations 26 In November 2018, unidentified hackers infiltrated Plaintiff’s account at a California 27 cryptocurrency exchange and stole approximately 500 Bitcoins. Compl. ¶¶ 16-18, 20. At the 1 investigative firm Kroll to locate the stolen cryptocurrency. Compl. ¶ 21. Kroll traced it to 2 addresses owned by custodial cryptocurrency firms Indodax and “Xapo.” Comp. ¶¶ 22-25, 34. 3 An investigation by Kroll also concluded that Indodax and “Xapo” employ inadequate policies 4 and procedures to prevent use of their services for malicious activity. See Compl. ¶¶ 33-44. 5 B. Procedural History 6 On June 1, 2020, Plaintiff filed the Complaint against Defendants. See generally Compl. 7 Plaintiff is a German resident. Compl. ¶ 1. Defendant Xapo, Inc. is a Delaware corporation with 8 its principal place of business in California. Compl. ¶ 2. Defendants Xapo (Gibraltar) Limited 9 and Indodax are foreign corporations. Compl. ¶¶ 3, 5. And the ten John Doe defendants are a 10 collection of unidentified hackers. Compl. ¶ 6. On July 29, 2020, Defendant filed this Motion. 11 See generally Mot. Plaintiff filed his Opposition on August 12, 2020. See generally Opp’n to 12 Mot. to Dismiss (“Opp.”), ECF 26. On August 19, 2020, Defendant filed its Reply. Reply in 13 Supp. of Mot. to Dismiss (“Reply”), ECF 28. This Court held a hearing on November 12, 2020. 14 Mot. Hr’g. 15 II. LEGAL STANDARD 16 A. Federal Rule of Civil Procedure 12(b)(6): Failure to State a Claim 17 “A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) for failure to state a 18 claim upon which relief can be granted ‘tests the legal sufficiency of a claim.’” Conservation 19 Force v. Salazar, 646 F.3d 1240, 1241-42 (9th Cir. 2011) (quoting Navarro v. Block, 250 F.3d 20 729, 732 (9th Cir. 2001)). When considering such a motion, the Court “accept[s] factual 21 allegations in the complaint as true and construe[s] the pleadings in the light most favorable to the 22 nonmoving party.” Manzarek v. St. Paul Fire & Marine Ins. Co., 519 F.3d 1025, 1031 (9th Cir. 23 2008). While a complaint typically need not contain detailed factual allegations, it “must contain 24 sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’” 25 Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 26 570 (2007)). A claim is facially plausible when it “allows the court to draw the reasonable 27 inference that the defendant is liable for the misconduct alleged.” Id. “Threadbare recitals of the B. Federal Rule of Civil Procedure 15(a): Leave to Amend 1 Under Federal Rule of Civil Procedure 15(a), the Court should freely grant leave to amend 2 “when justice so requires,” keeping in mind Rule 15’s underlying purpose “to facilitate decision 3 on the merits, rather than on the pleadings or technicalities.” Lopez v. Smith, 203 F.3d 1122, 1127 4 (9th Cir. 2000) (en banc) (internal quotation marks and alterations omitted). When dismissing a 5 complaint for failure to state a claim, “a district court should grant leave to amend even if no 6 request to amend the pleading was made, unless it determines that the pleading could not possibly 7 be cured by the allegation of other facts.” Id. at 1130 (internal quotation marks omitted). 8 III. DISCUSSION 9 Defendant raises numerous arguments in favor of dismissing the Complaint. These mostly 10 center on Plaintiff’s failure to plead sufficient facts showing actionable conduct, knowledge, or 11 loss. See generally Mot. For the reasons discussed below, this Court largely agrees. 12 A. Notice Requirements of Rule 8(a)(2) 13 “[A] complaint which lumps together multiple defendants in one broad allegation fails to 14 satisfy the notice requirement of Rule 8(a)(2).” Adobe Sys. Inc. v. Blue Source Grp., Inc., 125 F. 15 Supp. 3d 945, 964 (N.D. Cal. 2015) (internal quotation marks and alterations omitted). Here, the 16 Complaint lumps together defendants Xapo, Inc. and Xapo (Gibraltar) Limited, alleging conduct 17 by “Xapo” without distinguishing what each entity did. Compl. ¶¶ 2-4. Xapo, Inc. and Xapo 18 (Gibraltar) Limited are distinct corporations, the first domestic and the latter foreign. Compl. 19 ¶¶ 2-3; Mot. 14-15; Reply 15. In an amended pleading, Plaintiff must identify exactly what action 20 each took that caused his harm, without resorting to generalized allegations against “Xapo” (or 21 “Defendants”) as a whole.1 See In re Nexus 6P Prod. Liab. Litig., 293 F. Supp. 3d 888, 907-08 22 (N.D. Cal. 2018) (requiring the plaintiff to distinguish each defendant’s conduct). 23 B. California Penal Code § 496 24 In Count I, Plaintiff alleges violation of California Penal Code § 496 for possession of 25 stolen property. Comp. ¶¶ 45-53. The elements are “(1) that the property has been stolen; (2) that 26 27 1 the accused received, concealed or withheld it from its owner; and (3) that the accused knew the 2 property was stolen.” People v. Stuart, 272 Cal. App. 2d 653, 656 (1969). The third element, 3 “requires actual knowledge of or belief that the property is stolen.” U.S. v. Flores, 901 F.3d 1150, 4 1161 (9th Cir. 2018) (citing People v. Tessman, 223 Cal. App. 4th 1293, 1302 (2014)). 5 Here, Plaintiff suggests that Defendant’s knowledge can be inferred from its allegedly 6 inadequate “Know Your Customer” (“KYC”) and “Anti-Money-Laundering” (“AML”) policies 7 and procedures, claiming that, had Defendant followed reasonable compliance standards, it “knew 8 or should have known” of the stolen property. Comp. ¶¶ 40-41, 51. Plaintiff argues that the 9 extent of the inadequacy amounts to “willful blindness.” Opp. 8-9; see also People v. Scaggs, 153 10 Cal. App. 2d 339, 352 (1957) (“[T]he requisite guilty knowledge can be inferred from 11 circumstantial evidence.”). But the Complaint fails to show how Defendant’s KYC and AML 12 policies and procedures amounted to the type of willful blindness contemplated by § 496, as 13 opposed to mere negligence. See Freeney v. Bank of Am. Corp., No. CV 15-2376-JGB-PJWx, 14 2016 WL 5897773, at *11-12 (C.D. Cal. Aug. 4, 2016) (holding that the plaintiff failed to plead 15 the bank’s actual knowledge of converted funds despite being aware of several red flags). 16 Plaintiff further argues that even if Defendant was originally unaware of the theft, it 17 became aware upon receiving notice of the Complaint. Opp. 9; see also Scaggs, 153 Cal. App. 2d 18 at 352 (explaining that “even though a person is not aware that property is stolen when he first 19 comes into possession of it, if he subsequently learns of its stolen nature and then conceals or 20 withholds it from its true owner, he is guilty of a violation of [§] 496”). But filing a complaint 21 itself is insufficient to prove actual knowledge under § 496. See Kidron v. Movie Acquisition 22 Corp., 40 Cal. App. 4th 1571, 1586 (1995) (finding that service of the complaint gave the 23 defendant notice of a claim for fraud, not actual knowledge of the fraud itself). 24 In sum, Plaintiff fails to plead sufficient facts demonstrating Defendant’s knowledge that it 25 came into possession of stolen funds. Thus, Defendant’s Motion as to Count I is GRANTED 26 WITH LEAVE TO AMEND. 27 C. The Computer Fraud and Abuse Act (“CFAA”) 1 CFAA. Compl. ¶¶ 54-61. To succeed, Plaintiff must show that Defendant “(1) accessed a 2 protected computer, (2) without authorization or exceeding such authorization that was granted, 3 (3) knowingly and with intent to defraud, and thereby (4) furthered the intended fraud and 4 obtained anything of value.” U.S. v. Nosal, 930 F. Supp. 2d 1051, 1058 (N.D. Cal. 2013) (citing 5 LVRC Holdings LLC v. Brekka, 581 F.3d 1127, 1132 (9th Cir. 2009)) (internal quotation marks 6 and alterations omitted). Plaintiff’s Complaint fails to state a claim for the reasons below. 7 1. Failure to Plead Facts with Specificity Under Rule 9(b) 8 Under Federal Rule of Civil Procedure 9(b), a party must, in alleging fraud or mistake, 9 “state with particularity the circumstances constituting fraud or mistake.” For CFAA claims, 10 “Rule 9(b) plainly applies to § 1030(a)(4)’s requirement that the defendant’s acts further the 11 intended fraud.” Oracle Am., Inc. v. Serv. Key, LLC, No. C 12-00790 SBA, 2012 WL 6019580, at 12 *6 (N.D. Cal. Dec. 3, 2012). Here, Plaintiff alleges that Defendant assisted the unidentified 13 hackers by providing them “safe havens” in its custodial vaults to hide the stolen Bitcoins and that 14 Defendant “knew or should have known the property was so stolen or obtained.” Compl. ¶¶ 59- 15 60. To support these allegations, Plaintiff provides conclusory statements that investigative firm 16 Kroll found Defendant’s KYC and AML policies and procedures to be inadequate. See Compl. 17 ¶¶ 33-42. The pleadings for Plaintiff’s CFAA claim “should include the ‘who, what, when, where, 18 and how of the misconduct charged.’” In re Apple Inc. Device Performance Litig., 386 F. Supp. 19 3d 1155, 1181 (N.D. Cal. 2019) (quoting Kearns v. Ford Motor Co., 567 F.3d 1120, 1124 (9th Cir. 20 2009)). Thus, the Complaint suffers for lack of specificity in pleading the facts. 21 2. Failure to Allege the Requisite Conduct or Intent 22 The CFAA “was designed to target hacking, not misappropriation.” Koninklijke Philips 23 N.V. v. Elec-Tech Int’l Co., Ltd., No. 14-cv-02737-BLF, 2015 WL 1289984, at *4 (N.D. Cal. Mar. 24 20, 2015) (citing U.S. v. Nosal, 676 F.3d 854, 857 (9th Cir. 2012) (en banc)). As such, to violate 25 the statute a party must “engage in the hacking, not merely benefit from its results.” Id. 26 Furthermore, the “intent to defraud” element requires “knowing and specific conduct.” U.S. v. 27 Nosal, 844 F.3d 1024, 1032-33 (9th Cir. 2016). 1 Defendant had the requisite knowledge of the hacking itself. See generally Compl. Instead, the 2 Complaint alleges that Defendant had actual or constructive knowledge of its inadequate security 3 systems, which enabled the hacking to occur. Compl. ¶¶ 33-42, 59-60. Such conduct appears 4 beyond the scope of the CFAA, and Plaintiff does not cite any law to the contrary. See Opp. 5-6. 5 Plaintiff attempts to circumvent the fact that Defendant apparently did not participate in or 6 know about the hacking by asserting an aiding and abetting theory of liability. See Compl. ¶¶ 55, 7 59. Defendant argues that the CFAA does not provide a civil cause of action for aiding and 8 abetting. See Mot. 8-9; Reply 3, 7-8. Decisions on the issue are mixed. Compare COR Securities 9 Holdings Inc. v. Banc of California, N.A. No. SA CV 17-1403-DOC (JCGx), 2018 WL 4860032, 10 at *7 (C.D. Cal. Feb. 12, 2018) (finding that, in light of several recent Ninth Circuit decisions, the 11 court was not persuaded “that legal precedent forecloses a civil aiding and abetting claim under 12 [the] CFAA”) and Tracfone Wireless, Inc. v. Simply Wireless, Inc., 229 F. Supp. 3d 1284, 1296-97 13 (S.D. Fla. 2017) (finding that a civil “defendant can be held liable under the CFAA under an 14 aiding and abetting theory of liability”) with Flynn v. Liner Grode Stein Yankelevitz Sunshine 15 Regenstreif & Taylor LLP, No. 3:09-CV-00422-PMP-RAM, 2011 WL 2847712, at *3 (D. Nev. 16 July 15, 2011) (finding that “aiding and abetting civil liability does not exist under § 1030”) and 17 Advanced Fluid Sys., Inc. v. Huber, 28 F. Supp. 3d 306, 328 (M.D. Pa. 2014) (same). 18 But even if such liability exists, Plaintiff fails to allege facts demonstrating that Defendant 19 aided and abetted the hacking. Plaintiff asserts instead that Defendant provided a “safe haven” for 20 the stolen property in its custodial vaults. Compl. ¶ 59. But Plaintiff does not allege that 21 Defendant substantially assisted in the hacking itself, the primary violation. See generally 22 Compl.; see also Flynn, 2011 WL 2847712, at *3 (finding no aiding and abetting of the CFAA 23 where the defendants were alleged merely to have received the hacked information and to have 24 used it knowing its illicit source) (citing Ponce v. S.E.C., 345 F.3d 722, 737 (9th Cir. 2003)). 25 Instead, the CFAA claim appears to rely only on Defendant’s alleged acts or omissions after the 26 hacking occurred. See generally Compl. 27 Thus, the Complaint fails to allege conduct or knowledge, whether direct or indirect, 1 3. Failure to Allege a Cognizable “Loss” 2 The CFAA provides a civil remedy for “[a]ny person who suffers damage or loss by reason 3 of a violation of this section.” 18 U.S.C. § 1030(g). “Damage” is “any impairment to the integrity 4 or availability of data, a program, a system, or information.” 18 U.S.C. § 1030(e)(8). A “loss” is 5 “any reasonable cost to any victim, including the cost of responding to an offense, conducting a 6 damage assessment, and restoring the data, program, system, or information to its condition prior 7 to the offense, and any revenue lost, cost incurred, or other consequential damages incurred 8 because of interruption of service.” 18 U.S.C.§ 1030(e)(11). Additionally, a civil action for 9 violating § 1030(a)(4) may be brought only if the conduct caused a “loss to one or more persons 10 during any one-year period aggregating at least $5,000 in value.” Brekka, 581 F.3d at 1132; 18 11 U.S.C. § 1030(c)(4)(A)(i)(I). Courts have interpreted “loss” to mean “the types of costs . . . 12 related to fixing a computer.” Nexans Wires S.A. v. Sark-USA, Inc., 319 F. Supp. 2d 468, 475 13 (S.D.N.Y. 2004), aff’d, 166 F. Appx. 559 (2d Cir. 2006); see also Delacruz v. State Bar of Cal., 14 No. 16-cv-06858-BLF, 2018 WL 3077750, at *8 (N.D. Cal. Mar. 12, 2018), aff’d, 768 F. Appx. 15 632 (9th Cir. 2019). 16 Here, Plaintiff alleges that he suffered the loss of the value of his 500 Bitcoins. See 17 Compl. ¶¶ 18-32; Opp. 7. But losing the value of his stolen cryptocurrency is not a cognizable 18 loss under the CFAA. See DCR Mktg., Inc. v. Pereira, No. 19-CV-3249 (JPO), 2020 WL 91495, 19 at *2-3 (S.D.N.Y. Jan. 8, 2020) (finding that funds wrongfully transferred from the plaintiff’s bank 20 accounts were not cognizable losses under the CFAA); Clinton Plumbing & Heating of Trenton, 21 Inc. v. Ciaccio, Civil No. 09-2751, 2010 WL 4224473, at *5-7 (E.D. Pa. Oct. 22, 2010) (same). 22 Additionally, Plaintiff claims in his Opposition that he incurred more than $5,000 in costs 23 when he hired international investigative firm Kroll to trace his stolen Bitcoins. Opp. 7. While 24 Plaintiff may amend his Complaint to incorporate facts demonstrating these costs, it is unclear 25 how hiring an investigative firm to trace stolen funds constitutes a cognizable “loss” relating to 26 computers under the CFAA. See Tyco Int’l (US) Inc. v. John Does 1-3, No. 01 Civ. 3856 RCCDF, 27 2003 WL 21638205, at *1-2 (S.D.N.Y. July 11, 2003) (finding that costs incurred by hiring an 1 cognizable under the CFAA); see also Nexans Wires S.A., 319 F. Supp. 2d at 475-76 (explaining 2 what alleged conduct constitutes a “loss” under the CFAA). 3 In sum, Plaintiff has failed to state a claim under the CFAA. Accordingly, Defendant’s 4 Motion as to Count II is GRANTED WITH LEAVE TO AMEND.2 5 D. The Comprehensive Computer Data Access and Fraud Act (“CDAFA”)3 6 In Count III, Plaintiff alleges violation of California Penal Code § 502 et seq. for assisting 7 the unlawful access to a computer. Comp. ¶¶ 62-69. Although the Complaint does not state 8 specifically which subsection of the CDAFA Defendant violated, it appears that Plaintiff is 9 alleging violation of § 502(c)(6), which makes it unlawful to “[k]nowingly and without permission 10 provide[] or assist[] in providing a means of accessing a computer, computer system, or computer 11 network in violation of this section.” 12 “The CDAFA is California’s state-law analogue to the CFAA.” Ticketmaster L.L.C. v. 13 Prestige Ent. W., Inc., 315 F. Supp. 3d 1147, 1174 (C.D. Cal. 2018). While the CDAFA does not 14 impose a minimum of $5,000 in damages, the rest of “the necessary elements of [§] 502 do not 15 differ materially from the necessary elements of the CFAA.” Brodsky v. Apple Inc., 445 F. Supp. 16 3d 110, 131 (N.D. Cal. 2020) (quoting Multiven, Inc. v. Cisco Sys., Inc., 725 F. Supp. 2d 887, 895 17 (N.D. Cal. 2010)). Hence, the circumstances here suggest that the CDAFA claim fails for the 18 same reasons that the CFAA claim does. See id. at 131 (finding the claims “rise or fall” together). 19 First, because Plaintiff’s CDAFA claim “sound[s] in fraud,” it is subject to Rule 9(b) 20 pleading standards. See In re Apple Inc. Device Performance Litig., 386 F. Supp. 3d at 1181 21 (applying Rule 9(b)’s heightened pleading standards to the CFAA and CDAFA). Second, Plaintiff 22 fails to allege that Defendant was involved in the hacking itself, directly or indirectly. See 23 Claridge v. RockYou, Inc., 785 F. Supp. 2d 855, 863 (N.D. Cal. 2011) (finding that the alleged 24 conduct of failing to provide a sufficiently secure computer system fell outside the scope of 25 liability contemplated by § 502). Third, he fails to allege that Defendant had the requisite 26

27 2 Because Plaintiff has leave to amend, this Court does not rule on the issue of supplemental 1 knowledge to impose liability for assisting the hacking. See Spy Dialer, Inc. v. Reya LLC, No. ED 2 CV 18-1178 FMO (SHKx), 2018 WL 3689554, at *1 (C.D. Cal. July 26, 2018) (dismissing for 3 failure to show that the defendant intentionally accessed the plaintiff’s computers). Finally, while 4 the CDAFA does not impose the loss minimum that the CFAA does, the issue here is not the 5 amount, but whether the nature of Plaintiff’s loss is even cognizable under § 502. See Mot. 12-13; 6 Opp. 12; Reply 12. 7 Thus, Defendant’s Motion as to Count III is GRANTED WITH LEAVE TO AMEND. 8 E. Extraterritorial Reach of State-Law Claims 9 Finally, the Complaint alleges (1) that Plaintiff, a foreign resident, “maintained an account 10 [holding his Bitcoins] at a Northern California-based cryptocurrency exchange,” (2) that the 11 account was infiltrated by hackers, and (3) that the stolen funds were traced to hot wallet addresses 12 controlled by “Xapo.” Comp. ¶¶ 1, 2, 16, 20, 24. It does not appear that these allegations show a 13 sufficient nexus between California and Defendant’s alleged wrongful conduct. See Ehret v. Uber 14 Tech. Inc., 68 F. Supp. 3d 1121, 1129-33 (N.D. Cal. 2014) (holding that the alleged facts showed 15 “a sufficient nexus between California and the misrepresentations which form the basis of 16 Plaintiff’s claims” because the misrepresentations at issue “emanated from California”); Warner v. 17 Tinder Inc., 105 F. Supp. 3d 1083, 1096-97 (C.D. Cal. 2015) (dismissing a UCL claim for failure 18 to show extraterritorial reach where the complaint did not adequately allege that the harm 19 emanated from California); see also Sullivan v. Oracle Corp., 51 Cal. 4th 1191, 1206-09 (2011) 20 (upholding California’s strong presumption against the extraterritorial application of California 21 law). In an amended pleading, Plaintiff should clarify the Court’s extraterritorial reach over the 22 state law claims. 23 IV. ORDER 24 For the foregoing reasons, IT IS HEREBY ORDERED that Defendant’s Motion to 25 Dismiss is GRANTED WITH LEAVE TO AMEND. Plaintiffs shall file an amended complaint 26 no later than Monday, December 21, 2020. 27 1 Dated: November 20, 2020 5 mice) BETH LABSON FREEMAN 3 United States District Judge 4 5 6 7 8 9 10 11 a 12

© 15 16

Z 18 19 20 21 22 23 24 25 26 27 28