U.S. District Judge Paul Crotty of the New York Southern District. Photo: Rick Kopstein/ALM

Chinese technology firm Xunlei Ltd.'s offering of cryptocurrency through a cloud-computing rewards program did not violate China's ban on token-based financing, a Manhattan federal judge said Tuesday in dismissing a securities class action that accused the company of hiding alleged illegality from American investors.

The lawsuit, filed in 2018, claimed that the Shenzhen-based online service provider created massive volatility in its stock by declining to address third-party trading of OneCoin, a blockchain-based "cyrpto token" meant to reward customers for buying into its crowdsourced computing system.

According to the complaint, the program ran afoul of Chinese law that bars fundraising through coin offering. The plaintiffs, who acquired American Depository Shares from Xunlei, alleged in the suit that the company and its executives ignored illegal trading by third-party speculators, who created markets for OneCoin and, in turn, drove up participation in Xunlei's rewards program.

The complaint said that OneCoin's launch in September 2017 for a time made Xunlei one of the best performing stocks in the world, but uncertainty surrounding the technology caused significant fluctuations before the price bottomed out following a decline of more than 31 percentage points in January 2018.

"When the truth about Xunlei's misconduct and its lack of operational and financial controls was revealed, the value of the company [American Deposit Shares] declined precipitously as the prior artificial inflation no longer propped up its stock price," plaintiffs attorneys from Levi & Korsinsky wrote in the 22-page filing.

"The decline in Xunlei's ADS price was a direct result of the nature and extent of Defendants' fraud finally being revealed to investors and the market," they said.

Xunlei moved to dismiss the suit last August, arguing in court papers that the Chinese government had never found that the company acted illegally and did not impose any kind of ban on the program.

"The complaint's premise fails at its core, because the program is not illegal. But the complaint more fundamentally fails to state a claim because a company has no obligation under the securities laws to disparage its own program as 'illegal,' especially where, as here, all material aspects of the program are fully disclosed," the company's O'Melveny & Myers attorneys wrote.

On Thursday, U.S. District Judge Paul Crotty of the Southern District of New York agreed. In a 24-page opinion, Crotty said that the complaint made no allegations that Xunlei itself had ever offered any OneCoin-specific products or tried to raise money off of its rewards program. Instead, he said, the suit claimed the company had "stood idly by" as illegal trading occurred.

"Accepting the facts in the light most favorable to the plaintiffs, this all may true, but it is not illegal," Crotty said. "Plaintiffs' allegations essentially boil down to a theory of 'aiding and abetting' or 'willful blindness,' accusations for which liability does not attach under China's securities and fundraising laws."

Xunlei was represented by Jonathan Rosenberg and William K. Pao of O'Melveny & Myers.

The plaintiffs in the case were represented by Eduard Korsinsky and Patrick Vincent Dahlstrom, Omar Jafri, Jeremy Alan Lieberman and Joshua B. Silverman of Pomerantz Grossman Hufford Dahlstrom & Gross.

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