The summary judgment in favor of the SEC was issued on November 7, 2022 and the only issues addressed were whether LBRY did offer its LBC token in violation of securities laws (as an unregistered security without asserting any exemption from registration), and whether they received fair notice that registration with SEC was required prior to the SEC action.
The case, as any other such case, hinges on the Howey test, which requires a security to be issued for an in exchange for something of value for a stake in a common enterprise, with expectation of profit from the essential, managerial, or sole efforts of others (the issuer). Different circuits generally vary the test in some minor way and issue an opinion that hinges on whatever factors they deem most salient, so different circuits are not guaranteed to reach the same resulting verdict.
Why was SEC granted summary judgment?
Simply put, LBRY received some bad legal advice during its early marketing and launch stages.
Although LBRY contended that its LBC token was a utility token which was to be used up as ‘fuel’ on its blockchain based media platform (and not intended to be held for profit), the SEC contended that the token was actually treated as an investment and was represented as such by the issuer to investors/purchasers of the token.
It was clear that in various public and private statements LBRY did represent that LBC has the potential for long term capital gains and may be held long-term. The court concluded that EVEN IF some buyers of the token acquired it to spend on the platform and not hold for profit, that fact is irrelevant to they analysis of how the token was marketed by LBRY.
The SEC presented evidence which included private messages to investors and public posts on various platforms which clearly state that LBRY was in charge of the platform, of its development, and growth, as well as making various statements which implied that LBC was able to be deemed as a long-term investment.
Remember that ALL communications about a token or stock issuance by an issuer are deemed to be advertising, and must comply with disclosure laws pertaining to securities. Therefore, such statements much be plain and clear, truthful to the fullest extent possible, and not omit material information which a reasonable investor would wish to have before making an investment. Therefore, all public communications by an issuer may be used as evidence against such issuer in future legal actions. It would behoove a prudent issuer to run all its marketing materials through legal to ensure material good faith compliance with the law.
LBRY’s downfall began when it marketed LBC as a potential store of value or investment instead of solely as a utility used to power its platform. This type of activity must be carefully curated to ensure that even if, in the mind of any investor, they deem a given token to be a security/investment, there would be no basis found for such an assumption in public and private marketing communications by the issuer, in the event of future litigation or legal action. The above is stated with the pure assumption that the token is indeed a ‘utility’ token, and no registration was made, and no exemption from registration was used in the issuance.
Note that an issuer may be sued or legal action may be taken against it by a state or federal regulator, or any investor who believes he/she/it were misled. See Solana.
Was there fair notice that token registration was required?
The court deemed that there was fair notice given because the securities laws have been well established for decades, and it was the responsibility of the issuer to ascertain whether or not registration was indeed required.
To an extent the judge is most likely correct: with all the funds raised, LBRY was grossly negligent in not retaining competent securities counsel to ascertain whether its issuance was in compliance with securities laws.
At worst, any issuer may use Regulation D, described in great detail in other parts of this blog, to make an issuance to accredited investors, thereby not being required to go through the registration process.
Furthermore, registration on the pink sheets OTC markets, although more costly than Reg D, is easily and quickly achieved to enable public trading of the stock of the issuer, which may provide liquidity.
Regulation A Tier 1 or 2 are additional alternatives for issuance of securities, with their respective funding limits and relatively substantial compliance cost compared to Reg D.
There are furthermore a growing number of security token exchanges, which allow the trading of security tokens to accredited investors or the public under Reg D or Reg A, which in my view, will only grow as more and more blockchain projects are taken offline for being securities offered outside the limits of the securities regulations.
It most certainly will be the case that the future sees public trading of tokens similarly to the way NASDAQ or NYSE trades shares of public entities, after full registration with the SEC through an S-1 or Form 10.
Was the judge’s summary judgment correct?
No. My opinion is that the judge should not have made the legal conclusion that LBC was indisputably a ‘security’. He should have permitted that decision to be made by a jury, which would have carried more weight from a legal perspective. However, there would certainly be remaining questions of whether a jury could actually comprehend the intricacies of securities law in relation to the blockchain, and their verdict may have certainly been the opposite of the judge’s on this case. Nonetheless, the judge potentially usurped the authority granted to a jury, and there is potential that the summary judgment will be reversed on appeal and a full trial granted.