We have previously posted about the SEC lawsuit against LBRY. In that post, we noted that while the crypto community is rightfully focused on the Ripple case to see how the SEC will fare in court on enforcements alleging cryptocurrency offerings are a security, a lesser-known case may provide clarity first. And today that came to be. The federal district court in the LBRY case granted summary judgment in favor of the SEC. In so ruling, the Court found no reasonable trier of fact could reject the SEC’s contention that LBRY offered LBC as a security, and LBRY does not have a triable defense that it lacked fair notice.
As we also noted, the SEC will undoubtedly seek to use this decision in its case against Ripple. One of Ripple’s arguments against the SEC is that the SEC did not give it fair notice that its sale of LBC was subject to securities laws, thus violating the company’s right to due process. Ripple is making a similar argument. While each case turns on its specific facts, this ruling certainly makes the Ripple argument a bit more of an uphill battle. However, Ripple has some facts that were not addressed in the LBRY case. Thus, notwithstanding today’s decision, it is still possible that Ripple could prevail. However, even if it does, it may not be helpful to the crypto industry overall. The reason for this is that Ripple could prevail on facts unique to Ripple. Those facts may not be applicable to the next SEC defendant.
Even If A Token Has Utility It Can be a Security
One of the arguments that LBRY relied on was that its token had utility. LBRY alleged: (1) LBC is a utility token designed for use on the LBRY Blockchain, and (2) some unknown number of purchasers of LBC acquired it at least in part with the intention of using it rather than holding it as an investment. According to the Court decision, from there, LBRY leaps to the conclusion that LBC cannot be a security even if LBRY offered it as an investment. The Court found that LBRY is mistaken about both the facts and the law. We often hear from potential clients that they think their token is not a security because their token has utility. Even of that is true, it is not dispositive.
As the LBRY Court discussed, nothing in the case law suggests that a token with both consumptive and speculative uses cannot be sold as an investment contract. As the Court added:
- statements from a subset of LBC holders that they purchased LBC for use on the LBRY Blockchain is of limited relevance in determining whether LBRY offered it as a security
- while the subjective intent of the purchasers may have some bearing on the issue of whether they entered into investment contracts, we must focus our inquiry on what the purchasers were offered or promised
- while some unknown number of purchasers may have acquired LBC in part for consumptive in summary, what the evidence in the record discloses is that LBRY promoted LBC as an investment that would grow in value over time through the company’s development of the LBRY Network
The SEC’s Reliance on Howey To These Facts – Not Just ICOs - Does Not Violate Fair Notice
On the fair notice argument, the Court found that LBRY abandoned any broad claim that it lacked fair notice of the way in which the Howey test applies to digital tokens in general. Instead, it complains that it lacked fair notice because, until the SEC brought this action, “the Commission historically and consistently focused its guidance, as well as its enforcement efforts, exclusively on the issuance of digital assets in the context of an [Initial Coin Offering] ICO.” The Court added, the principal problem with LBRY’s fair notice argument is that it offers nothing more to support its position than its bald claim that this is the first case in which the SEC has attempted to enforce the registration requirement against an issuer of digital tokens that did not conduct an ICO. The Court went on to say that LBRY does not point to any specific statement by the SEC suggesting that companies need only comply with the registration requirement if they conduct an ICO. Nor does LBRY offer any persuasive reading of Howey that would cause a reasonable issuer to conclude that only ICOs are subject to the registration requirement.
The Court concluded: “The SEC has not based its enforcement action here on a novel interpretation of a rule that by its terms does not expressly prohibit the relevant conduct. Instead, the SEC has based its claim on a straightforward application of a venerable Supreme Court precedent that has been applied by hundreds of federal courts across the country over more than 70 years. While this may be the first time it has been used against an issuer of digital tokens that did not conduct an ICO, LBRY is in no position to claim that it did not receive fair notice that its conduct was unlawful.”
The SEC’s approach to regulation through enforcement has not been popular. But despite the unpopularity, until the laws are changed or the SEC provides a more viable path forward, the issuance of tokens under the current models will remain challenging. The SEC has been ramping up its enforcement efforts. This decision is likely to further that trend. If you are issuing or have issued tokens, you need to ensure that you have covered your legal bases.