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As revelations about the collapse of the FTX cryptocurrency exchange come to light, the United States District Court for the District of New Hampshire has issued an opinion pointing to increased regulation of cryptocurrencies through securities laws.
On 11/7/2022 at Securities Exchange Commission v LBRY, Inc., the court granted the Securities and Exchange Commission (“SEC”) motion for summary judgment against LBRY, Inc. (“LBRY”), a New Hampshire software company that issued a cryptocurrency called “LBRY Credits” or “LBC.” spent. The court ruled that LBRY had offered and sold LBC in violation of federal securities laws because LBC was an investment contract under the test established by the United States Supreme Court SEC vs. WJ Howey Co., 328 US 293 (1946).
According to the Howey test, a transaction is an investment contract if:
- It’s an investment
- The money is invested in a joint company
- There is an expectation of profits from the efforts of a promoter or a third party
In determining whether LBC was a security, the US District Court for the County of New Hampshire found that only the third item of the Howey test was in dispute. As a result, the court focused its analysis on whether LBRY’s LBC offerings resulted in investors having a reasonable expectation of gains to come from the entrepreneurial or managerial efforts of others.
In analyzing this question, the court found that LBRY released numerous statements that caused potential investors to “reasonably expect that LBC would appreciate in value as the company continues to monitor the development of the LBRY network,” noting that these explanations satisfied the third point of the Howey test. In particular, the court found that LBRY made the following statements:
- A blog post noting that “LBRY’s long-term value proposition is tremendous, but also depends on our team focusing on the task at hand: building this thing.” The post further noted that “[o]In the long-term interest of LBRY and the owners of [LBC] Are aligned.”
- An email from LBRY’s Chief Operating Officer explaining that the “opportunity is evident” and further stating: “Buy a bunch of credits, put them away safely and hope that in 1- 3 years, only 10% appreciate a lot Bitcoin has in recent years.”
- A Reddit post from LBRY’s community manager, explaining that LBC “will only be worth anything going forward if LBRY delivers on its promise to create a revolutionary way to share and monetize content.”
- An interview in which LBRY’s “technology evangelist” explains how the future “value of LBRY credits” would depend on the “success of our media marketplace”.
The court further noted that these and other statements were “representative of LBRY’s general message about LBC’s growth potential” and that such a message constituted “precisely the ‘not very subtle’ form of economic incentive” that underpins the third point the Howey content test.
To avoid summary judgment, LBRY argued:
- That it informed some potential buyers of LBC that the company was not offering its token as an investment
- This LBC is a utility token designed for use on the LBRY blockchain
- An unknown number of buyers acquired LBC with the intention of using it rather than holding it as an investment
In addressing these arguments, the court noted that a disclaimer cannot reverse the objective economic realities of a transaction and there is nothing in the case law to indicate that a token with both consumptive and speculative uses cannot be sold as an investment contract. Based on that analysis, the court dismissed LBRY’s defense and entered summary judgment in favor of the SEC. The SEC’s award of damages will be determined at a later date, but it is seeking a recovery of at least $11 million related to the sale of unauthorized securities.
The judgment of the court in SEC vs. LBRY likely signals increasing regulation of cryptocurrencies by the SEC and indicates that one use case for a cryptocurrency is not enough to avoid classification as a security under the Howey test. Companies using cryptocurrency as part of their business model need to understand this rapidly evolving law and have the compliance risks analyzed thoroughly to avoid the dangers of issuing an unauthorized security.
The content of this article is intended to provide a general guide to the topic. In relation to your specific circumstances, you should seek advice from a specialist.
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