New Hampshire Federal Court Finds That Cryptocurrency Was Issued In Violation Of Securities Laws – Fin Tech

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As revelations regarding 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 that hints at increased regulation of
cryptocurrencies through securities laws.

On November 7, 2022, in Securities Exchange Commission v. LBRY,
, the Court granted the Securities and Exchange
Commission’s (“SEC”) motion for summary judgment
against LBRY, Inc. (“LBRY”), a New Hampshire software
company that issued a cryptocurrency known as “LBRY
Credits” or “LBC.” The Court ruled that LBRY 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 in SEC v. W.J. Howey Co., 328 U.S.
293 (1946).

Under the Howey test, a transaction is an investment contract

  1. It is an investment of money
  2. The investment of money is in a common enterprise
  3. There is an expectation of profits derived from the efforts of
    a promoter or third party

In evaluating whether LBC was a security, the U.S. District
Court of the District of New Hampshire stated that only the third
prong of the Howey test was in dispute. As a result, the court
focused its analysis on whether 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.

In analyzing this issue, the Court found that LBRY published
numerous statements that led potential investors to
“reasonably expect that LBC would grow in value as the company
continued to oversee the development of the LBRY Network” and
determined that those statements satisfied the third prong of the
Howey test. In particular, the Court noted that LBRY made the
following representations:

  • A blog post noting “that the long-term value proposition
    of LBRY is tremendous, but also dependent on our team staying
    focused on the task at hand: building this thing.” The post
    further noted that “[o]ver the long-term, the interest of LBRY
    and the holders of [LBC] are aligned.”
  • An e-mail from LBRY’s chief operating officer explaining
    that the “opportunity is obvious” and further stating,
    “buy a bunch of credits, put them away safely, and hope that
    in 1-3 years we’ve appreciated even 10% of how much Bitcoin has
    in the past few years.”
  • A Reddit post by LBRY’s community manager explaining that
    the only way LBC will be “worth something in the future is if
    LBRY delivers on their promises to create a revolutionary way to
    share and monetize content.”
  • An interview in which LBRY’s “Technology
    Evangelist” explaining how the future “value of LBRY
    credits” would depend on “the success of our media

The Court further stated that these and other statements were
“representative of LBRY’s overall messaging about the
growth potential for LBC” and such messaging amounted to
“precisely the ‘not-very-subtle’ form of economic
inducement” satisfying the third prong of the Howey test.

In an effort to avoid summary judgment, LBRY argued:

  1. That it informed some potential purchasers of LBC that the
    company was not offering its token as an investment
  2. That LBC is a utility token designed for use on the LBRY
  3. Some unknown number of purchasers acquired LBC with the
    intention of using it rather than holding it as an investment

In addressing these arguments, the Court stated that a
disclaimer cannot undo the objective economic realities of a
transaction, and nothing in the case law suggests that a token with
both consumptive and speculative uses cannot be sold as an
investment contract. Based on that analysis, the Court rejected
LBRY’s defenses and entered summary judgment in favor of the
SEC. The damages to be awarded to the SEC will be determined at a
later date, but it is seeking disgorgement of at least $11 million
relating to the sale of unauthorized securities.

The Court’s ruling in SEC v. LBRY likely signals
increasing regulation of cryptocurrencies by the SEC and indicates
that a use case for a cryptocurrency is not enough to avoid
classification as a security under the Howey test. Companies that
use cryptocurrency as part of their business model need to
understand this rapidly developing law and have counsel thoroughly
analyze the compliance risks to avoid the dangers of issuing an
unauthorized security.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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