US District Court Judge Holds Plaintiffs Made Sufficient Showing That Token Is Security to Survive a Motion to Dismiss

December 14

Recent posts have discussed proceedings brought by the SEC in connection with ICOs that violated the securities laws.  But private plaintiffs can also bring suits alleging violations of securities laws based on a company’s failure to register a token as a security.  That is the claim being made in Solis v. Latium Network, Inc.  On December 10, 2018, the judge in that case decided that the allegations in the complaint were sufficient to survive a motion to dismiss (on which motion the allegations of the complaint are assumed to be true).

Latium conducted an ICO for its LATX tokens.  Plaintiff participated in the ICO and purchased $25,000 of LATX tokens on January 12, 2018.  On June 6, 2018, Plaintiff filed a two-count, putative class action alleging that Defendants violated the Securities Act of 1933 by offering and selling unregistered securities in the form of LATX tokens.

Such a claim requires that that the interest in question is a “security.”  That issue is determined based on the well-established three-part Howey test: “(1) an investment of money, (2) in a common enterprise, (3) with profits to come solely from the efforts of others.”  S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946).

Defendants acknowledged that the first prong of the Howey test was satisfied because participants in Latium’s ICO invested either U.S. dollars or Ether to purchase LATX tokens.

As to the “common enterprise” prong of the test, that can be established by showing “horizontal commonality,” which “is characterized by a pooling of investors’ contributions and distribution of profits and losses on a pro-rata basis among investors.”  Here, according to Plaintiff, an investor’s return on a Latium ICO investment was directly proportional to the amount of an investor’s financial stake and number of LATX tokens owned, thus satisfying the horizontal commonality test.

As to the third prong of the Howey test, Plaintiff averred that he and other investors were completely dependent on Defendants to market the ICO, raise funds to finance the tasking platform, manage those funds, develop and build the tasking platform, market the platform, maintain LATX’s listing on cryptocurrency exchanges for active trading, and ultimately maintain the platform.  The court held that Plaintiff had thus adequately alleged that any potential return on his investment in LATX tokens would have primarily resulted from Defendants’ efforts.

For these reasons, the court held that the allegations of the complaint were sufficient to survive a  motion to dismiss.

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David Zaslowsky has a degree in computer science and, before going to Yale Law School, was a computer programmer. He is currently the Chairman of the Litigation Department of the firm’s New York office. His practice focuses on international litigation and arbitration. He has been involved in cases in trial and appellate courts across the United States and before arbitral institutions around the world. Many of David’s cases, including some patent cases, have related to technology. Since 2008, David has been included in Chambers for his expertise in international arbitration.

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