SEC’s Supposed Setback on Token Issue Now Reversed

February 15

In November 2018, a U.S. District Court declined to accept the SEC’s argument that an ICO token was a “security.”  There are those who saw this as a setback for the SEC, although, as we wrote on this blog, that was an error because the judge merely held that he needed more evidence to resolve disputed questions of fact.  In the face of a request by the SEC for reconsideration, the judge has now reversed himself and issued the preliminary injunction requested by the SEC.

Our original post about this case reported on the facts.  In short, defendant Blockvest not only falsely claimed that it had obtained SEC approval for the offering of its BLV token, it also used the SEC seal without permission (a violation of federal law), promoted the ICO with a fake agency called the “Blockchain Exchange Commission” (using a graphic similar to the SEC’s seal and the same address as SEC headquarters), and offered the tokens in an unregistered securities offering in violation of the securities laws.

In response, Blockvest argued that it had not in fact sold any of its BLV tokens to the public but instead used the BLV tokens for purposes of testing during the development phase.  During this phase, 32 testers put a total of less than $10,000 of Bitcoin and Ethereum onto the Blockvest Exchange.  The BLV tokens were only designed for testing the platform and no tokens were released to the 32 testing participants.  In the future, they intended to issue a new utility token, BLVX, on the NEM Blockchain for exclusive use on the Blockvest Exchange.  Blockvest’s principal, Reginald Buddy Ringgold, testified that it was clear to the 32 testers that they were testing the platform, which is why Defendants did not obtain any earnings statements from them.

The court’s analysis in both cases centered on whether the BLV tokens were a security. As is standard in connection with determining the issue of whether an investment contract is a “security,” the court applied the Supreme Court’s Howey three-part test, which  requires “(1) an investment of money (2) in a common enterprise (3) with an expectation of profits produced by the efforts of others.”  The Howey test is an “objective inquiry into the character of the instrument or transaction offered based on what the purchasers were ‘led to expect.’”

As the court explained, however, before applying the Howey test, it was necessary to determine what exactly the Defendants offered to the 32  “investors” in Blockvest and to the 17 individuals who invested in Rosegold, the company that managed and financed Blockvest.  As to the 32 test investors, Ringgold testified that he knew them all and made oral presentations to them at seminars to explain the test tokens and provided declarations from nine of the test investors indicating they did not intend to make an investment when it tested the Blockvest exchange platform.  As to the 17 individual investors, Ringgold stated that they made personal loans to him which was the turned into a personal investment in Rosegold.

These disputed facts as to the 32 and the 17 precluded the court from issuing an injunction in its first decision.  And, on reconsideration, the Court denied Plaintiff’s motion for reconsideration as to the offers or promises made to the 32 test investors and 17 individual investors.  However, this time, that was not the end of the Court’s analysis of whether a “security” was offered.

SEC’s Alternative Theory Forms Basis For Finding a “Security”

As part of the reconsideration, however, the court said it was addressing the SEC’s alternative theory that the promotional materials presented on Defendants’ website, the Whitepaper posted online, and social media accounts concerning the ICO of the BLV token constituted an “offer” of unregistered “securities,” that contain materially false statements.  This, according to the SEC, constituted violations of Section 17(a) of the Securities Act, which applies to the “offer” or “sale” of securities and does not require a completed sale of securities.

The court first considered the Howey factors to consider whether Defendants’ promotion of the BLV token on their website and the Whitepaper constituted a “security.” It held that the Howey test was satisfied.  Defendants’ website and their Whitepaper’s invitation to potential investors to provide digital currency in return for BLV tokens satisfied the first “investment of money” prong of Howey.  Second, Blockvest’s website promoted a “common enterprise” because Blockvest claimed that the funds raised would be pooled and there would be a profit sharing formula.  Third, as described on the website and Whitepaper, the investors in Blockvest would be “passive” investors and the BLV tokens would generate “passive income.”

The court next considered whether there was an “offer” of the BLV tokens subject to Section 17(a).  The Securities Act defines “offer” to “include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value.”  Defendants argued that an offer requires a “manifestation of intent to be bound.” That argument, however, was based on a contract law analysis.  As the court explained, the securities law applies a different definition.  Under securities law, the definition of “offer” is broad and there is no requirement that performance must be possible or that the issuer must be able to legally bind a purchaser.  Thus, the court concluded that the contents of Defendants’ website, the Whitepaper and social media posts concerning the ICO of the BLV tokens to the public at large constituted an “offer” of “securities” under the Securities Act.

The other issue the court reconsidered with respect to whether to issue the preliminary injunction was the reasonable likelihood that the wrong would be repeated.  In the initial decision, the court considered the totality of the circumstances, without the benefit of full discovery, and concluded that the wrong would not be likely repeated because Ringgold recognized that mistakes were made and he intended to comply with the securities law.  The court also noted that Defendants had retained counsel.

On reconsideration, the court stated that Defendants had made the following misrepresentations on their website (the reference to which were strikingly absent from the initial decision): (i) falsely claiming their ICO has been “registered” and “approved” by the SEC, (ii)  falsely claiming their ICO has been approved or endorsed by the CFTC and the NFA by utilizing their logos and seals, (iii) falsely asserting they are “partnered” with and “audited by” the Deloitte accounting firm, and (iv) falsely creating a fictitious regulatory agency, the BEC, with a fake government seal, logo, and mission statement that are nearly identical to the SEC’s seal, logo and mission statement.  In addition, in a motion to withdraw as counsel, defense counsel explained that the firm found it necessary to terminate representation due to, among other things, Defendants instructing defense counsel to file certain documents that counsel could not certify under Federal Rule of Civil Procedure 11.  In light of the court’s order granting defense counsel’s motion to withdraw, the court was concerned that Defendants would resume their prior alleged fraudulent conduct.

For all the above reasons, the court granted the SEC’s request for a preliminary injunction.  Defendants were preliminarily enjoined from violating Section 17(a) of the Securities Act in the offer or sale of any security.

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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.
Jerome Tomas is Chair of the Firm's SEC and Financial Institutions Enforcement Group and has been recognized by Chambers for White Collar Crime & Government Investigations. He represents multinational companies faced with government investigations and conducts internal investigations to assess and remediate legal and compliance concerns in domestic and global operations. With his experience as a former member of the SEC Division of Enforcement’s Cyberforce, the agency’s internet and cyber fraud unit, Jerome regularly advises companies involved in data security breaches and incident response. Jerome now leads teams of lawyers to address government law enforcement perspectives and where necessary, meet and refute government legal theories of corporate and individual liability head-on, while also being pragmatic and business-oriented for management and boards to compete internationally.
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Patrick Dennien is an associate in the Firm’s Washington, DC office. He practices in white collar crime and corporate investigations, sanction systems of international organizations, money laundering risk and AML regulation, cryptocurrency risk and regulation, and corporate compliance programs. Prior to joining the Firm, Patrick worked for the World Bank’s anti-corruption arm, where he assessed the compliance programs of multinational companies, and advised on the development and implementation of effective compliance programs.

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