Digital Assets And The Securities Act of 1933

While the crypto community rightfully focuses on the Ripple case to see how the SEC will fare in court over enforcements alleging cryptocurrency offerings are a security, a lesser-known case may provide clarity first. The SEC’s lawsuit against LBRY is scheduled for trial in September 2022.

LBRY is a protocol that allows anyone to create applications that interact with digital content on the LBRY network. Applications built using this protocol allow creators to upload their work to the LBRY host network, price it per stream, download it, or give it away for free. When a creator posts something to LBRY, an entry is made on the LBRY blockchain. The issue of securities arises from the sale of LBRY credits as detailed below.


In 2021, the Securities and Exchange Commission (“SEC”) filed a complaint against LBRY, Inc. The SEC alleges that LBRY violated the Securities Act of 1933 by offering and selling unregistered securities when it sold “LBRY Credits” to numerous investors, including investors based in the United States, without registering with the SEC. The lawsuit alleges that the LBRY Loans were sold as investment contracts and therefore securities under the Howey test. SEC v. W.J. Howey Co., 328 US 293 (1946). Howey’s test holds that an “investment contract” exists when money is invested in a joint venture with a reasonable expectation of profit from the efforts of others. Whether a particular digital asset at the time of its offer or sale satisfies the Howey test depends on the specific facts and circumstances. In 2019, the SEC published the framework for the analysis of “investment contracts” of digital assets (“framework”) to help individuals determine whether their digital assets violate securities laws.

Seemingly following the Framework’s analysis, the lawsuit alleges that the LBRY Credits were sold to the public in exchange for contributions designed to build, build, and develop the LBRY Network. The lawsuit further alleges that LBRY Credit’s sales to institutional investors required the investor to wait a year before selling their investment. In addition, the complaint alleges that the LBRY Network used proceeds from LBRY Credit sales to pay operating costs to grow the LBRY Network. As alleged, LBRY received more than $11 million in US dollars, Bitcoin, and services from buyers who participated in its offering. All these accusations and more are mentioned in the analysis of the Framework.


In its answer, LBRY rejected the agency’s claims and asserted several affirmative defenses, including a defense of selective enforcement and violation of equal protection under the Fifth Amendment charge. LBRY claimed that when the SEC targeted it for enforcement action, the agency treated LBRY differently from other blockchain companies without justification and pursued its investigation in a manner that demonstrated selective treatment “based on malicious or malicious intent.” faith to harm LBRY”.

Petition for ruling on the allegations

In its response, the SEC challenged the defense saying it’s an “unlikely” as LBRY admits the agency has sued 42 other blockchain creators for alleged federal securities violations. The judgment motion on the allegations states that “[t]The SEC argues that LBRY’s admission necessarily precludes its selective enforcement defense because it undermines LBRY’s claim that it has been treated differently from other similarly situated digital currency creators.” Citing this argument, the district court dismissed LBRY’s selective execution defense.

motion to intervene

LBRY Foundation Inc. (the Foundation) filed a motion to intervene requesting permission to intervene in the SEC’s case against LBRY Inc. (LBRY). In its motion, the Foundation argued that it has fundamentally different interests than LBRY in this case, arising from their different corporate objectives. Specifically, the Foundation explained that it is a non-profit corporation working to promote the growth and use of the “bottom-up, community-driven” LBRY Protocol, and grants, not sells, LBC tokens to third parties. parties in favor of the objectives of the Foundation. On the other hand, he argued that LBRY is a for-profit trading company that raised funds from venture capital firms and individual investors in the form of convertible notes, and not through the sale of LBC tokens. The Foundation further argued that it likely had different litigation strategies that could lead to different outcomes than those pursued by LBRY due to its reliance on the utility of LBC tokens, while LBRY could continue its corporate existence without LBC coins, the Foundation would lose its fundamental purpose if the LBC tokens lose their usefulness.

The court ultimately denied the Foundation’s motion to intervene, citing the SEC’s response to the motion. One of the SEC’s arguments was that both LBRY and the Foundation requested dismissal on the basis that LBCs are not investment contracts and therefore are not securities. The SEC also argued that LBRY and the Foundation had common interests because the Foundation was a “spinoff” of LBRY that used LBRY’s resources and personnel to support its mission of promoting the growth and use of the LBRY network.

As part of its motion, the Foundation also noted that while both the Foundation and LBRY dispute the presence of a “joint venture” under Howey, the Foundation’s argument goes further by challenging the SEC’s “programmatic assertion” of that a network can be a “company”. ”—common or not—under Howey. The Foundation argued that the SEC’s interpretation of Howey goes beyond the Howey Court’s position, namely, that a business company that lists its securities by presenting current business and financial information relevant to determining future value of that company is the relevant entity for purposes of finding a “joint venture.” In questioning the SEC’s “newly expanded” understanding of “company” under Howey, the Foundation cited several reasons, including that: (1) LBRY is not a trading company or an issuer, (2) the LBCs do not grant holders rights against the current and future assets of LBRY, (3) the anticipated value of LBRY as a trading company does not determine the value of LBC, (4) LBRY registration does not enhance an LBC “investment decision” because the value of LBC is not tied to the value of LBRY, and (5) LBRY does not have a direct relationship through an LBC with an LBC holder such as has a securities issuer with a security holder. Unfortunately, because neither the SEC nor the court addressed the Foundation’s joint venture arguments in resolving the motion to intervene, the effectiveness of these arguments is currently unclear.

Summary Judgment and Judgment

Motions for summary judgment were due May 4, 2022. If the case is not resolved by summary judgment, it is scheduled to proceed to trial on September 7, 2022, before United States District Judge Paul J. Barbadoro. in the United States District Court for the District of New Hampshire.

SEC Compliance

There seems to be a perception within the blockchain space that some companies appear to be “getting away” with activity that could be considered an illegal offering of securities. However, as the court held in LBRY, this selective enforcement defense is not “a start because LBRY admits that the SEC has sued dozens of other digital currency creators for alleged violations of the Securities Act.”

As the LBRY court noted, this would lead to the nonsensical conclusion that an enforcement agency like the SEC would have to prosecute all potential violators in order to prosecute just one. Blockchain companies that are considering issuing tokens should be aware of this fact before jumping into the token issuance scene.

Implications in the Ripple case

The LBRY court recently denied a request from the SEC to extend the trial date by approximately one month. This means that, unless there are additional scheduling changes, the LBRY case will be decided before the SEC’s lawsuit against Ripple Labs for failing to register its offering and sale of XRP, a cryptocurrency issued by Ripple Labs (“the Ripple case” ). This is important because the court’s findings in the LBRY case could be cited in the Ripple case. In fact, the SEC has already attempted to include a ruling in the LBRY case as precedent against Ripple Labs in the Ripple case. Specifically, the SEC attempted to use the LBRY court’s ruling on LBRY’s selective execution affirmative defense as a sword against Ripple Labs’ fair notice affirmative defense. Although it does not appear to have changed the court’s decisions in the Ripple case, this demonstrates the potential interaction between the two cases, as both are pending final adjudication and could be decided very close to each other.

Another aspect to consider as both cases progress is whether the SEC has taken inconsistent positions in the LBRY and Ripple cases. Ripple Labs claims that the SEC has done so with respect to its treatment of a speech conducted by its former Director of Corporate Finance William Hinman. Ripple Labs noted this fact in its opposition to the SEC’s motion for partial reconsideration of the court’s order regarding the production of notes taken by an SEC official from meetings between the SEC and Ripple Labs, among others. In particular, Ripple Labs noted that while the SEC previously held, in both the Ripple and LBRY cases, that Mr. Hinman’s speech merely expressed Mr. Hinman’s “personal views,” it now took the position that the speech was the culmination. and reflected a policy process within the SEC’s Division of Corporate Finance. While it does not appear that the Ripple court has taken a position on this issue, this further demonstrates the importance of tracking the SEC’s positions in both cases, as the SEC’s positions in one case could certainly affect the outcome of the case. another case, especially if their positions within each are inconsistent.

Copyright © 2022, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume XII, Number 151