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  • L Hickey and S Pettigrove

US Court finds ERC-20 tokens sold to the public are an unlawful security

Updated: Nov 11, 2022

On 7 November, the United States District Court in New Hampshire found that a cryptographic token named LBC was a security under US law after the Securities and Exchange Commission (SEC) brought proceedings against the issuer of the token, LBRY, in May 2021. Barbadoro J gave a summary judgment in favour of the SEC against the issuer. LBRY operates Odysee, a decentralised video-sharing platform, which allows creators to acquire LBC and viewers the opportunity to earn cryptocurrency for watching videos in a "watch to earn" model.

Between 2016 and 2021, LBRY had sold LBC for over USD$11M in cash and Bitcoin. The SEC alleged that the offer of LBC was an "investment contract" and the offer had occurred without registration and disclosures required under US law. LBRY responded with two defences:

  1. that LBC tokens were not securities under US law; and

  2. if the LBC were securities, that the SEC had not given fair notice that the sale of LBC was regulated by securities laws and that the SEC was in violation of LBRY’s right to due process.

Barbadoro J ruled against LBRY finding:

No reasonable trier of fact could reject the SEC’s contention that LBRY offered LBC as a security, and LBRY does not have a triable defense that it lacked fair notice.

The decision examined the purposes and scope of the 1933 Securities Act and affirmed the decision of Reves v. Ernst & Young, 494 U.S. 56, 61 (1990). The principle established in Reves was that when Congress adopted the Securities Act:

"[Congress] enacted a definition of ‘security’ sufficiently broad to encompass virtually any instrument that might be sold as an investment".

This principle was used by Barbadoro J to expand the definition of a security so that is able to cover a token and through using the instrument of an investment contract. His Honour adapted the broad definition of this instrument established in SEC v. W.J . Howey Co 328 U.S 293 298-99 (1946) to cover

a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.

Barbadoro J focused on the intention of Congress when adopting the 1933 Securities Act and held that its scope is broad enough to cover a token, noting that:

Consistent with the broad reach of the Securities Act, [t]his definition ‘embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits’…The focus of the inquiry is on the objective economic realities of the transaction rather than the form that the transaction takes.

The District Court rejected LBRY’s argument that because LBC purchases were made with consumptive intent, the tokens are not a security.

Barbadoro J held that:

Nothing in the case law suggests that a token with both consumptive and speculative uses cannot be sold as an investment contract.

This decision to characterise these tokens as a security will have serious flow on effects in the US, where only a very small number of tokens have been offered as securities to date, and the SEC has been active in bringing actions against the sellers of tokens. Many of those actions have resulted in "no admissions" findings and fines, and the ongoing battle between the SEC and Ripple in relation to one such claim continues with summary judgment motions being filed in that case.

Ripple's lawyers are, however, advancing quite different and more comprehensive arguments than LBRY did in this decision, offering the potential of a different outcome which will be closely watched by the industry.


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