The Presumption of Token Innocence: Not a Security Until Proven a Security?
December 11, 2018
On November 27, 2018, a judge in the Southern District of California denied the Securities and Exchange Commission’s (the “SEC”) motion for a preliminary injunction against the backers of Blockvest, LLC (Blockvest), stating that the SEC had not shown that BLV tokens were “securities.” Although the court could ultimately determine that BLV tokens are securities, this ruling demonstrates the fact-specific nature of the inquiries in this space.
The judge had previously granted the SEC’s ex parte application for a temporary restraining order, including an asset freeze, against Blockvest arising from the SEC’s claims about Blockvest’s planned ICO of BLV tokens (the “BLV ICO”). In its complaint, the SEC alleged various Securities Act and Exchange Act securities fraud claims. According to the SEC’s complaint, Blockvest had falsely advertised on its website that the BLV ICO was registered and approved by the SEC, and approved and endorsed by the CFTC and the NFA. The SEC alleged that Blockvest referred to a non-existent Blockchain Exchange Commission, with a logo, mission statement, and seal similar to those of the SEC.
In litigating the SEC’s request for a preliminary injunction, Blockvest argued that the BLV tokens were not securities under the federal securities law, and therefore, the SEC’s causes of action, all of which turned upon BLV tokens being securities, should fail. In its November 27 decision, the court held that the SEC had not met its burden to demonstrate that Blockvest had violated securities laws and that an injunction was not warranted because the SEC had not shown that such violations would likely be repeated.
The court determined that the SEC had not provided evidence that the BLV token offering involved an investment of money and an expectation of profits, critical components of the “investment contract” test from SEC v. W.J. Howey Co. (the “Howey test”). With respect to the “investment of money” prong of the Howey test, the court focused its inquiry on what the purchasers were offered or promised rather than the subjective intent of the purchasers. Blockvest presented evidence (including testimony of the purchasers) that none of the purchasers was defrauded and that the only people who gave Blockvest money were friends and family that were helping Blockvest test the functionality of its platform and had no expectations of profits. Although the SEC argued that Blockvest’s website and whitepaper presented an offer of unregistered securities to the public, the court stated that the SEC had presumed that the 32 testers actually reviewed the Blockvest website or its whitepaper, but had failed to provide evidentiary support for this presumption. The court contrasted the SEC’s position with Blockvest’s founder’s deposition testimony that the only people who could actually use Blockvest’s website to buy BLV tokens were the 32 internal and sophisticated testers previously vetted by Blockvest. The court emphasized that there were disputed issues of material facts, and at this stage of the proceedings, it could not, without full discovery, make a determination as to whether BLV tokens were securities or if the Blockvest investors participated with an expectation of profits, which highlights the fact-specific nature of the analysis even where false statements may have been alleged.
The SEC has stated that determining whether a token is a security depends on the facts and circumstances regarding a particular token. Here, the court evaluated the evidence presented and concluded that, at this stage, the SEC’s evidence did not establish that BLV tokens are securities. Regardless of the ultimate outcome of this particular case, the SEC’s aggressive action against Blockvest is a reminder that companies and individuals would be well-served by carefully vetting and monitoring their websites, whitepapers, and other disclosures, with input and advice from key legal advisors.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Andrew J. Geist, an O’Melveny partner licensed to practice law in New York, David L. Kirman, an O’Melveny partner licensed to practice law in California, Robert Plesnarski, an O’Melveny partner licensed to practice law in the District of Columbia and Pennsylvania, Eric Sibbitt, an O’Melveny partner licensed to practice law in California and New York, Andrew A. Nizamian, an O’Melveny associate licensed to practice law in California, and Sydney Ryan, an O’Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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