SEC Scores a Win in Securities Case Against LBRY | Tonkon Torp LLP


If the ongoing fallout from the collapse of the offshore cryptocurrency exchange, FTX, and now BlockFi weren’t enough, cryptocurrency investors also lost a major battle last month in the US District Court for New Hampshire.

The district court sided with the SEC and found that LBRY, Inc. violated the Securities Act of 1933 by offering up its crypto assets. The ruling has potentially far-reaching implications; and prompted this lbry tweet: “The language used here sets an extraordinarily dangerous precedent that turns every cryptocurrency in the US into a security, including Ethereum.”

Is LBRY coin a security?

The SEC held that LBRY’s cryptocurrency LBC (LBRY credits) is an unregistered security. LBRY maintained that LBC is not a security at all, but an essential component of the LBRY blockchain. LBRY further argued that the SEC failed to give “fair notice” that LBC is subject to the Securities Laws and therefore could not take enforcement action.

In reaching its conclusion, the court relied on the ruling of the Supreme Court of the United States hello test, which defines a security as a “contract, transaction, or scheme whereby a person invests his money in a common enterprise and expects profit solely from the efforts of the promoter or a third party.” In the case of LBRY, the dispute centers on the third hello element: whether there was “an expectation of earnings derived solely from the efforts of the promoter or a third party”.

In determining whether LBC is a security and whether profits were expected to derive solely from the efforts of the promoter or a third party, the court relied on numerous communications, including emails, blog posts, and public proclamations, from the company. , from CEO Jeremy Kauffman and COO Josh Finer.

Some examples:

  • “…LBRY’s long-term value proposition is huge, but it also depends on our team staying focused on the task at hand: building this thing…in the long term, the best interests of LBRY and the owners of [LBC] they are aligned.”
  • An email to a potential investor, from Finer, explained that the company was “currently negotiating private placements of LBC with various [other] investors” and asked the addressee to reply “if there is interest”.
  • Finer explained how LBC are traded on “major crypto exchanges” and that trading volume is moving at a healthy pace. The “opportunity is obvious…”

The court considered these and several other comments in its decision. He also weighed in on LBRY’s counter-arguments that these comments, while not disavowed, “constitute only 0.25% of the ‘total number of posts and messages the company has published since its inception’.” LBRY also said that it informed some prospective buyers of LBC that the token was not being offered as an investment. However, the court concluded that the argument of the “volume” of the communication lacked weight; and rejected the disclaimer argument, writing, “a disclaimer cannot undo the objective economic realities of a transaction.”

Can Cryptocurrency Offerors Rely on a “Fair Notice” Argument?

Unfortunately for LBRY, the court also rejected the argument that it did not receive fair notice that it would be subject to state and federal securities laws. The court held: “The main problem with LBRY’s fair notice argument is that it offers nothing more to support its position than its simple assertion that this is the first case in which the SEC has attempted to enforce the registration requirement. against a digital token issuer. that it did not conduct an ICO (initial coin offering)… LBRY does not point to any specific statement from the SEC suggesting that companies should only meet the registration requirement if they conduct an ICO. Nor does LBRY offer any persuasive reading of hello that would cause a reasonable issuer to conclude that only ICOs are subject to the registration requirement.”

What does this mean for the cryptocurrency industry?

A district court opinion likely won’t make “all cryptocurrency in the US a security,” but it continues the trend of enforcement agencies and courts increasingly leaning toward characterizing crypto assets as securities. The ruling provides more cover for regulators to impose stricter regulations and take enforcement action under current rules against offerors of crypto assets, particularly around tokens used in the manner chosen by LBRY.

Similarly, it provides plaintiffs with more fodder to bring private causes of action for losses against coin or token issuers. In Oregon, where courts take the broadest possible view of what constitutes a security, a written district court opinion such as this will give plaintiffs ammunition to uphold securities law claims that may include the award of attorney’s fees. If a token or other asset is considered a security in other jurisdictions, it will definitely be considered a security in Oregon.