Sale of Crypto Assets by Promoter Held to Be Sale of Securities Despite Claimed Utility Use of Digital Assets by at Least Some Purchasers

Cryptoassets issued and promoted by LBRY, Inc. (LBRY) and sold directly to investors constituted investment contracts and thus securities, requiring registration with the Securities and Exchange Commission (SEC), ruled a federal court in New Hampshire on November 7. The decision was issued in response to a complaint filed by the SEC in March 2021, against LBRY, and cross-motions for summary judgment filed subsequently by both parties. The Complaint alleged that LBRY engaged in sales of digital assets known as LBRY credits (LBC) from at least July 2016 to February 2021, without required registration.

According to the Court, LBRY argued that (1) it had not offered LBCs as securities because, among other reasons, at least some purchasers had acquired LBCs for actual use on a blockchain network developed by LBRY, and (2) even if the SEC believed that LBCs were securities, LBRY did not have fair notice of such a view prior to the filing of the SEC’s complaint (and thus its due process rights were violated). The Court rejected both arguments in granting summary judgment to the SEC.

The decision was issued by the US District Court, District of New Hampshire, by the Hon. Paul J. Barbadoro, US District Judge.

Apparently, LBRY was a company founded in 2015 to enable users to shares videos and other digital content using distributed ledger technology without a singular host. To help fund its development, the company sold LBCs directly to investors through LBRY applications and some digital asset platforms.

Principally relying on the 1946 decision of the US Supreme Court, in SEC v. W.J. Howey Co., the Court held that, as sold by the defendant, LBCs were investment contracts as they represented an investment of money in a common enterprise with the expectation of profits through the efforts of a promoter or a third party. In its decision, the Court pointed to numerous statements by the defendant that it believed evidenced LBRY’s promotion of LBC in a manner consistent with the standards of Howey for an investment contract. The Court rejected arguments by LBRY that (1) LBCs were utility tokens intended for use on the LBRY blockchain and some persons solely acquired LBCs for such use; (2) statements promoting LBC’s price or value were only a small percentage of LBRY’s overall publicity regarding LBC; and (3) a disclaimer it provided all investors noting that purchases of LBCs should not be construed as an investment undercut the SEC’s views that it sold LBCs as securities. The Court concluded that “the objective economic realities of LBRY’s offerings of LBC establish that it was offering it as a security.”

The Court also rejected arguments by defendant that, because its sale of LBCs did not occur in the context of an initial coin offering it was not given fair notice of the SEC’s regulatory views. The defendant had claimed that all prior SEC enforcement actions and guidance regarding required registration of digital asset securities solely arose in the context of an ICO.

This decision was publicized while cross-motions for summary judgment are pending before a US federal court in New York City in the SEC’s enforcement action against Ripple Labs, Inc. and two of its principals. In that enforcement action, the SEC alleged that the defendants engaged in the unlawful offer and sale of XRP cryptoassets which it termed “securities.”

Importantly, in Howey, the Supreme Court did not conclude that the orange groves (let alone oranges) at issue were a security; rather it was the circumstance of land sales contracts and service contracts together that constituted an investment contract and thus, a security.