A federal court in California that in November 2018 denied the Securities and Exchange Commission a preliminary injunction against defendants it accused of engaging in a fraudulent and unlawful offer and sale of securities in connection with a new cryptoasset reversed course and granted the preliminary injunction last week. The defendants in this matter are Blockvest, LLC, and its chairman and founder, Reginald Buddy Ringgold, III a/k/a Rasool Abdul Rahim El.
The court ruled that the defendants’ promotion of BLV tokens on Blockvest's website constituted the unlawful offer of unregistered securities. The court grounded its decision on the application of the three-prong indicia of an investment contract – a type of security – articulated by the US Supreme Court in its 1946 decision SEC v. WJ Howey: (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profits based solely on the managerial or entrepreneurial efforts of others. (Click here to access the Howey decision.)
The court held that the defendants’ use of a website to solicit persons to provide digital currencies for BLV tokens satisfied the investment of money prong of Howey, while the website’s indication that funds raised would be pooled and profits shared satisfied Howey’s common enterprise and expectation of profits requirements. The court rejected defendants’ argument that an offer requires “manifestation of [an] intent to be bound,” saying that while that standard might be relevant for an assessment of an offer under contract law, it was too narrow a view in connection with application of securities laws.
Previously, the court declined to find the SEC had made a prima facie case of past violations of securities law because there were disputed facts regarding what was promised to actual BLV purchasers. However, in reconsidering the SEC’s request for a preliminary injunction, the court accepted the SEC’s alternative argument that, standing alone, solicitations on Blockvest’s website constituted an offer of unregistered securities because solely an unlawful offer (without regard to sales) was sufficient to demonstrate a securities law violation.
Additionally, the court said that, absent a preliminary injunction, there was a “reasonable likelihood” of a future violation by defendants. In its earlier denial of a preliminary injunction, the court concluded that a reoccurrence of any law violation was unlikely because of the involvement of outside counsel. However, in light of defendants’ reference to a fictitious government agency on their website to promote their initial coin offering of BLVs as safe and the withdrawal of defendants’ counsel with no substitute counsel named, the court had no confidence that another violation would not reoccur.
In its original complaint, the SEC claimed the defendants falsely asserted that their ICO received regulatory approval from the SEC when it did not, and misrepresented that Blockvest had a relationship with Deloitte, a public accounting firm, when it did not. The SEC also charged that the defendants misrepresented their status with the National Futures Association even after being warned to stop such false claims by NFA. The SEC further alleged that defendants said on their website that a US government agency known as the Blockchain Exchange Commission (with the nearly identical seal, logo and mission statement of the SEC) oversaw the BLV offering when, in fact, the BEC does not exist.
(Click here for background regarding this matter in the article “California Federal Court Rejects SEC’s View That Purportedly Fraudulent ICO Constituted a Security Offering – At Least for Now” in the December 2, 2018 edition of Bridging the Week.)
In other legal and regulatory developments involving cryptoassets:
- SEC Commissioner Rails Against Cryptoasset Regulation by Enforcement: In a speech at the University of Missouri Law School on February 8, SEC Commissioner Hester Peirce cautioned her agency not to “cast the Howey net so wide” that it characterizes all capital raises for decentralized blockchain projects as unlawful security offerings when, in fact, many project participants – such as miners as well as persons providing development services or other tasks – may play a material role in the success of the enterprise. She noted that while the SEC has “spoken indirectly” through enforcement actions about what type of digital token offerings might be security offerings, that was not her “preferred method for setting expectations” for people trying to raise money for innovative projects. She indicated that staff is currently working on supervisory guidance to help provide better clarity but ultimately it might be Congress that has to “resolve the ambiguities” in existing law by mandating that at least some digital assets be regarded as a different asset class than securities.
- NYSE Arca Seeks SEC Review of Rule Change to List Bitcoin Index ETF: NYSE Arca filed with the SEC a proposed rule change to trade and list shares of Bitwise Bitcoin ETF Trust to be managed and controlled by Bitwise Investment Advisers, LLC. The objective of the Trust is to mimic performance of the Bitwise Bitcoin Total Return Index which was designed to measure the performance of bitcoin as traded on 10 cryptocurrency exchanges located in the United States, Europe and Asia. The SEC will accept public comments on the proposed rule change through March 8. In January, Cboe BZX Exchange, Inc. filed with the SEC for a second time a proposed rule change to enable trading of shares of SolidX bitcoin shares issued by the VanEck SolidX Bitcoin Trust. (Click here for background in the article “Try It Again, VanEck SolidX Bitcoin Trust” in the February 3, 2019 edition of Bridging the Week.)
- Bitcoin Cash Miners Claim Voting Against a Fork Is Not an Anti-Trust Law Violation: Bitmain Inc. and Payward Ventures Inc (Kraken) along with its chief executive officer, Jesse Powell, filed papers in a federal court in Florida to support their motions to have dismissed an anti-trust lawsuit filed against them and others by United American Corp. related to their purported nefarious roles in the forking of Bitcoin Cash in November 2018. UAC claimed that the three defendants (and others) conspired to effectuate the hard fork in violation of anti-trust laws by, among things, redirecting computer mining capacity to Bitcoin Cash that had been dedicated to other cryptocurrencies in order to increase the probability that a particular hard fork would be adopted as opposed to an alternative fork favored by UAC. The three defendants claimed that UAC did not allege sufficient facts to demonstrate a conscious commitment to a common scheme to restrain trade as required to show a violation of applicable anti-trust law. (Click here for background regarding this lawsuit in the article “Lawsuit Filed Over Recent Bitcoin Cash Hard Fork” in the December 9, 2018 edition of Bridging the Week.)
Legal Weeds and My View: Kik Interactive, Inc., a Canada-based company that developed and promotes a widely popular internet chat messaging service, and the Kin Ecosystem Foundation, an associated entity (collectively, “Kik”), recently published a private letter they received from the SEC in November 2018 threatening legal action against them for their distribution of Kin digital tokens in violation of registration requirements of US securities laws. The SEC letter invited Kik to submit a response to explain why the Commission should not bring charges against it. Kik submitted a letter to the SEC on December 10, 2018, opposing an enforcement action and recently made this response public too.
According to Kik in its SEC submission, Kin is a digital currency and not subject to US securities registration requirements. It has consumptive uses not only within the Kin ecosystem but also for non-ecosystem transactions, and is used to pay developers as well as to reward Kik users for performing certain functions. Additionally, the presale of Kin tokens, the 2017 initial coin offering of Kin, and the subsequent distributions of Kin tokens did not constitute investment contracts, argued Kik, because there was no common enterprise between Kik on the one hand and Kin purchasers on the other, and no expectation by any Kin purchaser of profits from the entrepreneurial or managerial efforts of Kik. Although Kin holders may profit from market transactions, Kik never offered or promoted Kin as a "passive investment opportunity" and "never promised [itself] to create and operate an exchange or to re-purchase Kin." Potential expectations of profits through resales on exchanges would solely be based on market forces, argued Kik. In short, Kik claimed its offer and sale of Kin tokens did not satisfy the requirements of Howey and thus did not constitute an unlawful offer or sale of securities.
In its letter to Kik, the SEC did not allege that Kik engaged in any fraudulent or similar nefarious activity.
The outcome of this back and forth between the SEC and Kik is well worth following. Kik appears ready and willing, if necessary, to fight any potential SEC enforcement action and appears to have taken significant steps to avoid the Kin token being considered a security digital token.
As I have noted many times before, and as increasingly recognized by other jurisdictions worldwide, not all cryptoasset distributions constitute securities offerings. The SEC has taken a very broad view of Howey that would effectively make all initial and subsequent sales of collectibles that are perceived to have potential secondary market value – like beanie babies and special edition automobiles – securities offerings or sales. This outcome does not appear contemplated by US securities laws or common sense.