Dec 03, 2018
On October 11, 2018, the Securities and Exchange Commission (SEC) announced that it had obtained a temporary restraining order (TRO) from the United States District Court for the Southern District of California halting a planned "initial coin offering" (ICO) of blockchain tokens called "BLV," which its backers falsely claimed was approved by the SEC. The order also halted ongoing pre-ICO sales by the company, Blockvest LLC, and its founder, Reginald Buddy Ringgold, III. The SEC complaint alleged that Blockvest falsely claimed its ICO and its affiliates received regulatory approval from various agencies, including the SEC. According to the SEC's complaint, Blockvest and Ringgold were using the SEC seal without permission, a violation of federal law, and falsely claiming their ICO was "licensed and regulated" by various agencies, including the SEC. The complaint also alleged that Ringgold promoted the ICO with a fake agency he created called the "Blockchain Exchange Commission," using a graphic similar to the SEC's seal and the same address as SEC headquarters. The SEC's complaint charged Blockvest and Ringgold with violating the antifraud and securities registration provisions of the federal securities laws and sought injunctions, return of ill-gotten gains with interest and penalties, and a bar against Ringgold participating in offering any securities, including digital securities, in the future or making misrepresentations about regulatory approval.
On November 27, 2018, the District Court denied the SEC's motion for a preliminary injunction extending the TRO. A number of blockchain industry commentators have asserted that the court found that the BLV tokens were not securities, has dismissed the SEC's claims, has reined in the SEC's enforcement efforts, etc., and that the decision represents a significant development in the framework of regulating ICOs. We disagree.
In denying the preliminary injunction, the court ruled that the SEC had not met the legal standard for a preliminary injunction, which is (1) a prima facie case of previous violations of federal securities laws and (2) a reasonable likelihood that the wrong will be repeated. The question of whether there was a violation of the securities laws turns in part on whether the BLV tokens were in fact "securities" as defined by the Securities Act of 1933 (the "Securities Act"), whether they were "offered" or "sold," etc.
The TRO was initially granted based on accepting the SEC's characterization of the defendants' marketing and advertising of its token through its websites and media posts, which the SEC took as factually accurate descriptions of the defendants' activities. The defendants then responded that Blockvest had never sold any tokens to the public and has only one investor, a limited liability partnership owned by Ringgold. They claimed that Blockvest utilized BLV tokens during a testing and development phase and that a total of 32 "partner testers" were involved, who put a total of less than $10,000 worth of Bitcoin and Ethereum into Blockvest, where half of it remains, the other half having been used to pay "transactional fees." They asserted that no BLV tokens were ever released from the Blockvest platform to the 32 testing participants, that they were designed only for testing the platform and that the testers would could not keep or remove BLV tokens from the platform.
Essentially, the defendants said, "Never mind what our web site and social media posts said; we didn't actually do that." For example, the court stated, "Based on Defendants' postings on the internet, the SEC asserted that Blockvest raised more than $2.5 million from investors. . .Defendants. . .explain that they did not raise $2.5 million from the public but instead the $2.5 million was supposed to be based on a transaction with [an individual]. However, the transaction eventually collapsed and they admit the social media posts were overly optimistic." And, "The 'buy now' button on the website did not disclose that it was only for testors [sic] and management but once a person moved forward, he or she could not buy any coins because the platform was not 'live.'"
In its ruling, the court determined that it was unable at this stage to determine whether "the test BLV tokens were 'securities' under the first prong of [the] Howey [test]1," because "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." The Court indicated that its decision might be different after full discovery and resolution of disputed issues of material facts.
It is important to remember that this decision was made without any finding of facts, or finding of law on the merits of whether the BLV token was a security. The decision did not reject application of the Howey test as the proper standard for determining whether a blockchain token is a security subject to regulation. Nor did the Court address the issues relating to the defendants' use of the SEC's seal, claims that the ICO was "licensed and regulated," or references to a made-up crypto regulatory authority.
While the ruling does indicate (unsurprisingly) that courts will hold the SEC to its legal burden of proof, rather than accepting at face value the SEC Enforcement Division's allegations that a token is a security, it does not in our view represent a significant development in the law of ICO regulation. The case will presumably move to a trial on the merits if the SEC elects to continue to pursue its action.
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1 This test was first established by the U.S. Supreme Court in SEC v. W. J. Howey Co. (1946), and has been elaborated in subsequent cases. In essence, it looks at four factors to determine whether an arrangement is an "investment contract" that constitutes a security under the Securities Act: whether the arrangement involves (1) an investment of money or other item of value, (2) in a common enterprise, (3) where there is a reasonable expectation of profit from the investment, and (4) the profit comes from the entrepreneurial or managerial efforts of a promoter or third party.