In a recent decision, a federal judge granted summary judgment for the Securities and Exchange Commission (SEC) finding that the LBC cryptocurrency token qualifies as a security. While the ruling is confined to this specific token, it represents a victory for the SEC’s assertions that many cryptocurrencies, including so called “utility tokens,” represent securities that need to be registered with the agency. The Court also held that the makers of the LBC token, LBRY, Inc., had fair notice that the token was subject to the securities laws. Considering the ongoing class actions and enforcement proceedings litigating this issue across several cases, companies operating in the cryptocurrency space, including cryptocurrency exchanges, should follow this development to assess any possible impact on their businesses.
In the case, SEC v. LBRY, Inc., Ca. No. 21-cv-00260 (D.N.H. November 7, 2022), the SEC alleged that the LBC token constituted an unregistered security and filed suit in federal court asserting that LBRY was in violation of Section 5 of the Securities Act for offering and selling the token. After both sides filed cross motions for summary judgment, the core issue before the Court was whether, under the Howey Test, “LBRY’s offerings of LBC led investors to have ‘a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.’” (quoting United Hous. Found. v. Forman, 421 U.S. 837, 852 (1975)). LBRY argued that LBC was a utility token, in that its primary purpose was consumptive and used to enable token holders to access video and other digital content on the LBRY Network. Therefore, it claimed that purchasers of its token expected to use them, rather than hold them as an investment. The SEC, however, presented numerous public and private posts and communications by LBRY which SEC claimed highlighted the value proposition of the token for potential investors.
In granting the SEC’s motion, the Court pointed to these communications, holding that “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” and “the objective economic realities of LBRY’s offerings of LBC establish that it was offering it as a security.” The Court also held that despite this being a first-of-its-kind enforcement action, LBRY could not claim it did not have fair notice that it was in violation of the law, given the SEC’s “straightforward application of a venerable Supreme Court precedent” that is the Howey Test.
While the Howey Test is fact-specific and the holding is limited to this specific token, the SEC and class action plaintiffs litigating alleged securities laws violations by token companies and cryptocurrency exchanges will likely seek to apply the Court’s findings to their cases.