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Exclusive: Tezos founders push for legal bailout from Swiss foundation

[December 01, 2017] By Steve Stecklow, Anna Irrera and Brenna Hughes Neghaiwi

NEW YORK/ZURICH (Reuters) - The couple behind the embattled Tezos cryptocurrency tech project wants the Swiss-based Tezos Foundation to cover their costs for lawsuits accusing them of fraud related to an online fundraiser it ran, people familiar with the matter told Reuters.

That would mean contributors to the fundraiser, known as an initial coin offering, would be indirectly footing the bill. The contributors have yet to receive anything, even though the project in July raised $232 million. The Tezos Foundation, which controls the proceeds, so far has not agreed to the couples’ request, the people said. The foundation was established to develop the project.

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.

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.

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 authority told Reuters, "It is not the Foundation Authority's task nor its responsibility to approve private law agreements."

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Tezos co-founder and CTO Arthur Breitman and his wife and co-founder Kathleen Breitman respond to questions during the Money 20/20 conference in Las Vegas, Nevada, U.S. on October 24, 2017. REUTERS/Steve Marcus

The contract also says that some Tezos software code would be put in the public domain prior to the fundraiser. The foundation later told Reuters that it has a license to release the code and will do so "at an appropriate time before the launch of the main network."

Documents provided to participants in the fundraiser did not 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, reviewed the agreement at Reuters' request. He said 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.

"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.

(Reporting by Steve Stecklow and Anna Irrera in New York and Brenna Hughes Neghaiwi in Zurich; Additional reporting by Michael Shields in Zurich; Editing by Lauren Tara LaCapra and Leslie Adler)

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