Cali Federal Court Denies SEC: ICO Not A Security...Yet

On November 27, 2018, a California federal court denied the SEC’s motion for a preliminary injunction against Blockvest, LLC, a Wyoming limited liability company that was set up to exchange cryptocurrencies but never become operational.

This decision is interesting because it is one of few decisions in which a court sided with the proponents of an ICO rather than the regulatory agency alleging violations of U.S. law. In this matter, the SEC claimed Blockvest violated several U.S. laws including:

  • Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act’) and Rule 10b-5(b);

  • Section 10(b) of the Exchange Act and Rule 10b-5(a) and Rule 10b-5(c);

  • Fraud in violation of Section 17(a)(2) of the Securities Act of 1933 (“Securities Act”);

  • Fraud in violation of Sections 17(a)(1) and 17(a)(3) of the Securities Act; and

  • Sections 5(a) and 5(c) of the Securities Act for the offer and sale of unregistered securities.

Specifically, the complaint alleges that Defendants offered and sold unregistered securities in the form of digital tokens called BLV’s by way of the following pre-sales: 1) a private sale (with a 50% bonus); 2) a “pre-sale”(with a 20% bonus); and 3) the $100 million ICO launch on December 1, 2018. Additionally, the SEC stated Blockvest made numerous false statements in their sale of these tokens to investors, including claiming to operate a licensed and regulated exchange and an index fund. Blockvest also purported to operate an ICO “registered” and “approved” by the SEC, CFTC, and National Futures Association (”NFA”) and used the seals of these organizations on its website.

To be charged with making false or misleading statements in the sale of unregistered securities, Blockvest must have in fact sold an unregistered security. Therefore, the court analyzed Blockvest’s receipt of money and the circumstances surrounding its fundraising and applied the test from Howey, which defines a security as (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profits, (4) derived from the efforts of others. 

The SEC argued Howey was clearly met in this case: Blockvest sold securities by raising more than $2.5 million from investors, there was a “common enterprise” because Blockvest claimed that the funds raised will be pooled and there would be a profit sharing formula. Finally, as described on Blockvest website and whitepaper, the investors in Blockvest would be passive investors and they would depend entirely on Defendants’ efforts. 

In sum, Blockvest argued that the exchange never left the testing phase and it merely used the money taken from individuals to test the exchange of BLV tokens on the platform.

Based on these differing accounts and a lack of dispositive evidence for either side, the court stated the SEC fell short in satisfying the “investment of money with an expectation of profits” prong of Howey: “[p]laintiff has not demonstrated that the 32 test investors had an expectation of profits.”

The Court needed to see credible evidence of the “investors” intention  The court found the investor’s mere noting of the words “Blockvest” or “coins” on their checks was not sufficient to demonstrate what promotional materials or economic inducements these purchasers were presented with prior to their investments.

Essentially, the SEC failed to support its argument with competent evidence. It is important to note this decision was made at the preliminary injunction stage, noting “on application for a preliminary injunction the court is not bound to decide doubtful and difficult questions of law or disputed questions of fact.” The court stated:

Plaintiff and Defendants provide starkly different facts as to what the 32 test investors relied on, in terms of promotional materials, information, economic inducements or oral representations at the seminars, before they purchased the test BLV tokens. Therefore, because there are disputed issues of fact, the Court cannot make a determination whether the test BLV tokens were “securities” under the first prong of Howey.

Accordingly, the SEC will have an opportunity to depose witnesses and prove Blockvest’s acceptance of funds constituted a security.

Although the ruling is unlikely to impact the ultimate outcome of the case, the decision is interesting because it is the first federal decision in which a court ruled against the SEC when interpreting the Howey test in the context of an ICO. The court refused to allow the SEC to presume its case and demanded more competent evidence regarding the expectations of those who gave money to Blockvest.

This case offers fodder for defendants of alleged Initial Coin Offerings, although it falls far short from offering a safe haven from the SEC for the vast majority of ICOs.

 Case: Securities and Exchange Commission v. Blockvest, LLC and Reginald Buddy Ringgold, III a/k/a Rasool Abdul Rahim El, Civil Action No. 18-CV-2287-GPC (BLM) (S.D. Cal. filed Oct. 3, 2018)

If you are raising capital in connection with your blockchain project, you should consult an experienced securities attorney to ensure you comply with federal and state laws and regulations.

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