On November 28, 2018, the United States District Court for the Southern District of California denied the U.S. Securities and Exchange Commission’s (SEC) request for a preliminary injunction against Defendants Blockvest, LLC (Blockvest) and Blockvest’s founder and chairman Reginald Buddy Ringgold, III (Ringgold). Securities and Exchange Commission v. Blockvest, LLC, et al.[1]

The SEC alleged that Blockvest and Ringgold were offering and selling unregistered securities in the form of digital assets called BLV tokens. According to the SEC, Blockvest sold the tokens in an initial coin offering (ICO) that, according to the SEC’s complaint, began with pre-sales starting in March 2018.

In rejecting the SEC’s request for preliminary injunction, U.S. District Judge Gonzalo Curiel provided what appears to be the first federal judicial decision finding that the SEC had failed to sufficiently demonstrate that the digital asset offered in connection with an ICO was a security. However, it should be noted that the decision largely turned on the Court’s conclusion that there were significant disputed facts before the Court.

Background

On October 3, 2018, the SEC filed its complaint seeking to enjoin Blockvest’s ICO. The SEC alleged that Blockvest and Ringgold had (1) falsely claimed that their ICO had been registered and approved by the SEC, (2) falsely represented that that they had created the first licensed and regulated tokenized cryptocurrency exchange and index fund, (3) illegally used the SEC’s seal to promote its offering, and (4) made a number of other false representations including those related to its registration status with other federal regulators.

On October 11, 2018, Judge Curiel issued an order granting the SEC’s ex parte request for a temporary restraining order and froze the assets involved in the Blockvest ICO, effectively shutting down Blockvest’s planned ICO.

Judge Curiel’s PI Decision

The SEC subsequently made a motion for a preliminary injunction. To be entitled to relief, the SEC was required to demonstrate (i) a prima facie case of a past securities violation and (ii) a reasonable likelihood that the wrong would be repeated. Judge Curiel concluded that—at that stage of the proceedings, where there had not been full discovery and where there were disputed issues of material facts—the SEC had not demonstrated that the BLV token was a security and, absent a security, there could be showing of a past violation of the federal securities laws.

Specifically, Judge Curiel focused on the elements of the so-called “Howey” test, formulated by the Supreme Court of the United States in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), and used to determine whether a particular instrument constitutes a security under the federal securities laws. In Howey, the Court held that a security is “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.”

Defendants argued that they had not sold any BLV tokens to the public, but instead used the BLV tokens for purposes of testing during the development phase of Blockvest’s platform. During this phase, defendants asserted that 32 testers—largely friends and family—put less than $10,000 of Bitcoin and Ethereum onto the Blockvest Exchange. Defendants contended that the BLV tokens were only designed for testing the platform and that no tokens were released to the 32 testing participants.

Moreover, Defendants argued that there is no common enterprise and that the tokens do not represent an interest in or obligation of a corporation or other business, and, as a consequence, their BLV tokens cannot be deemed securities.

Judge Curiel held that disputed facts prevented him from making a determination of whether the BLVs were securities under the “investment of money” prong of the Howey test. The Court further held that the SEC did not demonstrate that the 32 test participants had an “expectation of profits” prior to purchasing the test BLVs, and thus that it could not determine whether the test BLVs are securities under the second Howey prong. Accordingly, the Court denied the SEC’s request for injunctive relief, finding that the SEC had neither demonstrated a prima facie showing that there has been a violation of the federal securities laws, or, in light of the defendants’ commitment to put the offering on hold, that there was a reasonable likelihood that defendants would repeat the alleged wrongdoing.

Analysis

It is important not to read too much into the decision. Judge Curiel was deciding the SEC’s motion for a preliminary injunction. He did not make a finding that there was no securities offering—only that, based on the evidence before him, the SEC had not provided sufficient evidence that BLVs are securities. The decision does not end the SEC’s case. And in the meantime, the ICO will not move forward—the same result the SEC was seeking through its motion for injunctive relief.