The SEC Does Not Always Win – At Least For Now
December 3, 2018
Court Cannot Determine if Tokens are Securities without Full Discovery
Digital token issuers should take heed for a startup has taken on the U.S. Securities and Exchange Commission (the “SEC”) in a federal court and succeeded in the first round. Although the court had previously granted the SEC’s request for a temporary restraining order (which was an ex parte motion, meaning that the defendant was not able to oppose the motion) and had frozen assets involved in the initial coin offering, on November 27, 2018, U.S District Judge Gonzalo Curiel of the Southern District of California denied the SEC’s motion for a preliminary injunction against Blockvest.1 In such a motion, the party moving for an injunction (here, the SEC) has the burden to demonstrate the factors justifying relief, which in this case meant that the SEC had to show (1) a prima facie case of previous violations or federal securities laws and (2) a reasonable likelihood that the wrong will be repeated.2 In this case, the first prong of the proof resolves around whether Blockvest BLV tokens offered were securities under the “Howey Test” which requires (1) an investment of money (2) in a common enterprise (3) with an expectation of profits from the efforts of others. Despite the SEC’s allegations that Blockvest had raised in excess of USD 2.5 million through an ICO, Blockvest claimed that the deal had never transpired and that less than USD 10,000 was raised from 32 sophisticated vetted participants solely for testing purposes. Blockvest contended that the SEC had failed to meet its burden under the Howey Test and the court agreed. The parties presented widely divergent facts as to what information the investors relied on prior to purchasing the BLV tokens and the court concluded that the SEC had not demonstrated the sale of the BLV tokens was a sale of “securities” and has therefore was not able to establish a prima facie case that there had been a previous violation of the federal securities laws. The court also found that the SEC had not demonstrated a reasonable likelihood that the wrong will be repeated, and did not grant the SEC’s request for a preliminary injunction. Although the decision is encouraging for digital token issuers, it is narrow and rests on a unique set of facts. Contrary to some reports, this decision should not be construed as an all-out defeat of the SEC. Indeed, although the SEC has not commented yet, it is not unreasonable to expect that the SEC will continue to prosecute this case and seek a permanent injunction against Blockvest. The decision does demonstrate that courts will delve into the facts and that the SEC cannot succeed without meeting its evidentiary burden of proof. Moreover, this opinion does provide support for the contention that the Howey test not only involves an analysis of a purchaser’s intent but also an understanding of what was actually offered to and relied upon by the purchaser prior to committing funds. Thus, a digital issuer should be cognizant that its statements and advertisements will be taken into account by courts when conducting analyses under the Howey Test.
Boxer and Rapper Settle Touting Charges
On November 29, 2018 the SEC announced that it had formally settled its first cases involving touting violations relating to initial coin offerings. The cases charged professional boxer Floyd Mayweather, Jr. and music producer Khaled Khaled (aka DJ Khaled) with failing to disclose compensation for promoting initial coin offerings and violating the anti-touting rules of the federal securities laws. Each agreed to pay disgorgement, penalties and interest. Mayweather is banned from promoting any securities for three years, while Khaled agreed to a similar two-year ban.
Some Insights from SEC Chairman Jay Clayton on ICOs and Crypto ETFs
In a fireside chat at Consensus:Invest 2018, SEC Chairman Jay Clayton speaking in his personal capacity shared some valuable insights. With respect to whether or not a token is deemed a security, he stated that “you should start with the assumption it is a security” if it is used to “finance a venture”. He also added that market manipulation “needs to be addressed” before a cryptocurrency ETF is approved.
Use Your Bitcoin to Pay Your Taxes, At Least in Ohio
The State of Ohio announced that it will allow businesses operating in the state to pay state business taxes with bitcoin, using BitPay to process payments.
1 SEC v. Blockvest LLC et al., case number 3:18-cv-02287 (Dist. Southern California).
2 SEC v. Unique Fin. Concepts, Inc., 196 F.3d 1195, 1199 n. 2 (11th Cir. 1999) (citing Mgmt. Dynamics, Inc., 515 F.2d at 806-07.