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(Reuters) – Digital media company LBRY Inc claimed in a series of tweets on Monday that the entire cryptocurrency industry is now threatened, according to a federal judge in New Hampshire ruled that its digital tokens are securities that must be registered with the US Securities and Exchange Commission.
“The language used here sets an extraordinarily dangerous precedent that makes any cryptocurrency in the United States a security,” LBRY tweeted. “Even after five years of fighting and a court ruling, we still honestly don’t know how to legally launch a public blockchain in the US”
Should the cryptocurrency industry panic?
There is no doubt that the ruling by US District Judge Paul Barbadoro of Concord granting summary judgment to the SEC bodes ill for creators of crypto tokens concerned about SEC regulation. The judge, as my colleague Jody Godoy reported on Monday, rejected LBRY’s arguments that its tokens are a genuine cryptocurrency used primarily to pay for services on its blockchain-backed data network and that the SEC failed to provide fair warning that it would sue unregistered tokens that did not enter the market in an initial coin offering.
Barbadoro unequivocally held that LBRY’s tokens were investment contracts under the US Supreme Court’s 1946 test in SEC v. Howey, In the LBRY case, the judge said, the only contested element of the three-pronged Howey test was whether token buyers were led to expect profits based on LBRY’s efforts. Barbadoro said that early investors and blockchain miners who received tokens had such an expectation because they knew that LBRY’s operations were related to the token’s increased value.
In perhaps the ruling’s most consequential language, Barbadoro said that any reasonable buyer of tokens would expect LBRY to use its own share — hundreds of millions of tokens — to increase the value of the cryptocurrency. That structure alone, the judge said, “would drive buyers away [LBRY tokens] to expect that they would also profit from their holdings of [the tokens] as a result of LBRY’s persistent efforts.”
It’s ominous language given that the LBRY model, where blockchain developers keep a large stash of the tokens that serve as currency on their platforms, is not at all unusual.
But I would suggest that the industry wait for a decision in the SEC’s closely watched case against Ripple Labs Inc. before deciding that the sky is falling.
In a summary judgment brief pending before U.S. District Judge Analisa Torres in Manhattan, Ripple has made arguments that LBRY’s lawyers at Perkins Coie did not — including a position apparently designed to appeal to the current Supreme Court’s preoccupation with historical practice.
Ripple, whose lawyers declined to provide me with a statement on the LBRY ruling, has also developed a much more robust record than LBRY to support its claim that the SEC failed to provide fair notice of which crypto tokens it would consider be securities.
The SEC, which declined to comment specifically on the LBRY or Ripple cases, said in an email that “digital assets that qualify as securities under the criteria long ago established by the Supreme Court cannot receive approval from the securities laws .”
commission summary judgment in the Ripple case is apparently replete with background facts about what the SEC claims is a year-long $2 billion offering of unregistered securities by a company that had ample warning that it was in violation of the law. Nevertheless, its legal arguments for why Ripple’s tokens qualify as securities under the Howey test are quite similar to those the SEC claimed in the LBRY case.
But Ripple (and its chairman and CEO, who are also defendants in the SEC case) offered various defenses than LBRY. Ripple reached back to state law cases underlying the Supreme Court’s Howey ruling to argue that an investment contract can only be considered a security if the promoter and investor entered into a contract that required the promoter to take specific actions for the benefit of the investor and gave the investor a specific right to share in the profits generated by the promoter’s efforts. Defense counsel from Debevoise & Plimpton; Kellogg, Hansen, Todd, Figel & Frederick; Paul, Weiss, Rifkind, Wharton & Garrison; and Cleary Gottlieb Steen & Hamilton said there was no such contract between the Ripple defendants and alleged investors who received tokens through donations, gifts and even sales.
Ripple’s brief argued that even after Howey, neither the 2nd U.S. Circuit Court of Appeals nor the Supreme Court has held the sale of an asset to be an investment contract unless the promoter and buyer had specific rights and obligations. Ripple drew an analogy between its tokens and diamonds, arguing that when DeBeers sells rough diamonds, it does not enter into investment contracts with buyers, even though those buyers expect to profit from the diamonds they have purchased.
In the LBRY case, remember, Barbadoro said that LBRY’s control of hundreds of millions of tokens was a signal to investors that the company would act to support their value. Ripple again pointed to the diamond market to argue otherwise: The SEC does not regulate diamond purchases as securities trading, Ripple said, despite DeBeers’ marketing efforts.
Ripple also asserts a much more sweeping fair notice defense than LBRY, which merely argued that the SEC previously acted only when token issuers conducted public offerings. The New Hampshire judge said LBRY failed to show that the SEC promised to enforce the Howey test only for tokens sold in ICOs, and that the Howey test itself contained no such limitation. (LBRY counsel from Perkins Coie declined to comment on the differences between their arguments and Ripple’s.)
Ripple argued in its response to the SEC’s summary judgment motion that the commission’s own files reflect years of confusion and uncertainty within the agency about how or whether to regulate cryptocurrencies. “No wonder market participants were unsure what to think,” Ripple said. At the very least, it argued, the notice issue must hash out at trial.
There are nearly 700 journal entries to date in the Ripple case compared to only 86 in LBRY. If the SEC wins summary judgment against Ripple, the industry will have real reason to worry.
US securities regulators win case against crypto firm LBRY
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