Federal Court Sides With The SEC, Sounding The Alarm For All Crypto Projects – Fin Tech

On November 7, the United States District Court of New Hampshire
(in the First Circuit Court of Appeals) granted a motion for
summary judgment made by the SEC against LBRY, potentially opening
the door for almost every cryptocurrency being deemed a
“security” under U.S. federal law.

The decision stems from an SEC complaint filed in March 2021,
which alleged that LBRY was selling an “unregistered
security” through its issuance of LBRY Credit
(“LBC“), the native digital token of the LBRY
platform. According to the SEC’s complaint, LBRY raised more
than $11 million in U.S. dollars, Bitcoin and services from
“investors” between 2016 and 2020 without filing a
registration statement (or otherwise complying with an available
exemption from registration).

LBRY operates the decentralized content-sharing platform Odysee.
LBRY’s ambitious aims to compete as a decentralized YouTube
sought to incentivize participants to create or view content using
LBC as a reward. Odysee offers users the ability to earn LBC for
watching videos, while creators earn LBC for sharing content.
According to LBRY’s website, users paid a fee in LBC to
interact with Odysee for anything beyond viewing free content.
Thus, LBRY argued that the LBC token was a “utility
token” since it had a “consumptive use” within the
LBRY ecosystem. Additionally, LBRY further argued that the LBC was
not a security because it was generally not “sold” to
participants, but was instead largely claimed for free or
“earned” by users, while LBRY retained a large portion of
the LBC token for its own account in reserve.

Arguing in support of its claims, the SEC relied upon the
long-standing definition of what constitutes a “security”
in the United States – the Howey Test. To determine
whether or not an offering is deemed a “security,” all
four prongs of the Howey Test have to be satisfied: Investors would
have to make (1) an investment of money (2) in a common enterprise
(3) with an expectation of profits (4) to be derived solely from
the efforts of the promotor or a third party.

In rendering its decision, the Court examined LBRY’s
representations to prospective purchasers (including those on the
secondary market) as well as its business model. While LBRY had
included multiple disclaimers on its site that it did not view LBC
as being securities, the Court cited multiple statements by LBRY
that were “representative of LBRY’s overall messaging
about the growth potential for LBC,” supporting the SEC’s
view that “potential investors would understand that LBRY was
pitching a speculative value proposition for its digital
token.” In one blog post, LBRY stated that “the long-term
value proposition of LBRY is tremendous, but also dependent on our
team staying focused on the task at hand: building this
thing.” Another post on Reddit from a product manager with
LBRY stated “worth something in the future . . . if LBRY
delivers on their promises.” This somewhat minimal commentary
made by LBRY’s representatives as to the potential future value
of the LBC token was significant.

In echoing the result from SEC v. Telegram, the Court further held that
legal disclaimers, such as the ones utilized by LBRY as a means of
distancing itself from having LBC being classified as a security,
“cannot undo the objective economic realities of a
transaction.”

Further, the Court concluded that any reasonable investor
familiar with LBRY’s business model would understand that LBRY
expected LBC to increase in value through LBRY’s managerial and
entrepreneurial efforts. The Court’s position was bolstered by
statements made by LBRY’s own CEO, Jeremy Kauffman:
“LBRY’s profitability turned on its ability to grow the
value of LBC by increasing usage of the LBRY network.”

In an interview with Coindesk, Kauffman responded to the
Court’s ruling: “The SEC vs LBRY case establishes a
precedent that threatens the entire U.S. cryptocurrency industry.
Under the SEC vs LBRY standard, almost every cryptocurrency,
including Ether and Dogecoin, are securities.”

The lessons here are simple:

1. While LBRY is likely to appeal the decision, it appears to
   ratify the SEC’s position that of the thousands of
   cryptocurrency tokens available in the crypto market, the vast
   majority are securities. This also affirms the SEC’s
   enforcement position as to whether both sales and non-sale
   issuances of utility tokens may be classified as unregistered
   securities offerings.




2. Language matters. Don’t rely on website disclaimers as a
   blanket line of defense against regulators. Generally speaking, if
   a reasonable person would acquire a token for investment purposes,
   or the “economic realities” of the transaction make that
   investment motive apparent, then the entire project could be at
   risk if appropriate steps to comply with the existing laws are not
   taken.

The full decision is linked here: https://fingfx.thomsonreuters.com/gfx/legaldocs/mopakmakkpa/SECURITIES%20LBRY%20ruling.pdf

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