On November 27, 2018, the United States District Court for the Southern District of California denied a motion for preliminary injunction by the Securities and Exchange Commission against a proposed initial coin offering by BlockVest, LLC, concluding that the SEC did not demonstrate that BlockVest’s BLV tokens were “securities” under federal securities law. This represents the first legal rebuke by a court of the SEC under the so-called Howey test for determining whether a token constitutes a “security”.
While the result of this case may be welcome news to the many ICO issuers (and potential issuers) who have been grappling with enhanced enforcement efforts by the SEC in the digital token arena over the past 18 months, and embolden some such issuers to take a firmer stand against regulatory actions against them, it is important to recognize that this is a very fact-specific ruling by a district court that only applies in a narrow range of contexts, and thus is unlikely to stem the tide of regulatory actions.
The issuer of tokens in this particular matter, BlockVest, LLC, was set up to become the “first licensed and regulated tokenized cryptocurrency exchange and index fund based in the U.S.” To implement this business plan, BlockVest intended to issue its BLV tokens in three stages: (A) a private sale (with a 50%) bonus through April 30, 2018; (B) a “pre-sale” from July 1, 2018 through October 6, 2018; and (C) a $100 million initial coin offering to be launched on December 1, 2018.
The SEC’s complaint alleged, among other violations of federal securities laws, that BLV tokens are “securities”, and thus that the offer and sale of the BLV tokens constitutes an unregistered securities offering in violation of federal securities laws.
Following the filing of the complaint, the court granted the SEC’s ex parte motion for a temporary restraining order against BlockVest and its operations, which was based solely on the SEC’s version of the facts and did not involve an analysis of the BLV tokens under the now familiar criteria for determining whether an investment contract constitutes a “security” established in the Supreme Court case SEC v. W.J. Howey Co. Under the Howey test, the BLV tokens would be deemed to be securities if they involved (1) an investment of money, (2) in a common enterprise (3) with an expectation of profits produced by the efforts of others.
In the materials that they submitted to the court in opposition to the preliminary injunction motion, the defendants presented a different rendering of the facts than presented by the SEC. Specifically, the defendants asserted that they have not sold (or released) any BLV tokens to the public, but rather the tokens were only used to test the platform during the development phase (and were only designed for that purpose), and such intended use was generally known to the small and well-vetted group of token purchasers. The defendants also presented a different view on the materials that the purchasers relied upon and the expectations of such purchasers with respect to the tokens, which tokens BlockVest claimed the investors could not keep or remove from the platform.
In its order denying the motion, the court analyzed the BLV tokens under the first prong (“investment of money”) and third prong (“expectation of profits”) of the Howey test. With respect to the first prong – “investment of money” – the court found that the parties “provide starkly different facts as to what the test investors relied on, in terms of promotional materials, information, economic inducements or oral representations . . . before they purchased the rest BLV tokens,” and thus the court concluded that it could not determine whether the BLV tokens issued during the test phase of the BlockVest platform were “securities” under the first prong of Howey. With respect to the third prong – “expectation of profits” – the court noted that the SEC had not met its burden of proof to support a claim that there was an expectation of profits by the purchasers, with profits being viewed as either capital appreciation or a participation in earnings.
Based upon the varying renditions of the facts as noted above, and further noting that the agreement by the defendants to stop any pursuit of the ICO removed the reasonable likelihood of continuing harm, the court denied the preliminary injunction motion.
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