On November 1, 2021, a jury in federal district court for the district of Connecticut (court) found, in the class action lawsuit Audet et al. v. Fraser (Audet, 3:16-cv-940 (MPS)), that defendant's cryptocurrency offerings were not investment contracts and therefore not securities subject to the Securities and Exchange Act of 1934 (Exchange Act) under SEC v. Howey Co. (328 U.S. 293). The jury's finding in this case contradicts the position taken by the SEC in its enforcement under similar and analogous fact patterns in this area over the past several years under the Howey test (see Practice Note, SEC Regulation of Digital Assets).

Plaintiffs alleged that from approximately March 2014 through December 2014, defendant Stuart Fraser sold to over 10,000 investors an array of products and investment contracts that defendant claimed would yield profits from mining or otherwise investing in cryptocurrency. The amended complaint stated that defendant's activities amounted to a Ponzi scheme, in that defendant came to owe investors a return that was larger than defendant's actual return, and some investors were paid back over time with monies from other investors.

In June 2014, defendant sold shares in its mining operations via investment contracts they called "Hashlets." The Hashlet contracts entitled the holders to a share in the profits of defendant's computing power that was devoted to virtual currency mining. However, defendant did not have the computer power in his computing centers to support the amount of Hashlets sold.

In November 2014, defendant announced that he was planning to launch a new cryptocurrency called Paycoin (initially called Hashcoin). In advance of Paycoin’s launch, defendant began offering "Hashpoints" to its customers. Hashpoints were convertible promissory notes that could be purchased or mined and exchanged for Paycoin once Paycoin launched. Defendant intended to stall Bitcoin payments to Hashpoint holders because defendant's could not make the payments. Defendant encouraged Hashpoint holders to convert their interest to Paycoin. In an effort to lend legitimacy to the Paycoin, defendant represented to investors that there was support for Paycoin by banks, investment firms, and retailers, which they knew was untrue. Plaintiffs specifically alleged that defendant convinced customers to acquire Hashpoints by misrepresenting in an initial coin offering (ICO) flowchart that Paycoin would have an estimated value of $80-$100 per coin and defendant knew or should have known that this representation was highly speculative at best. Defendant argued that the elements of the Howey test were not present in this case:

Specifically, defendant asserted that the products did not meet the Howey requirement that profits be derived solely from the efforts of others, since investors' individual decisions affected their profits, as acknowledged in testimony by two of the named plaintiffs.

On the primary question of whether plaintiffs proved that the various cryptocurrency products offered by defendant were investments contracts, the jury found that they were not. The jury instructions directed the jurors to apply the Howey test, developed by the US Supreme Court in 1946 to determine whether an investment contract has been created that is subject to the US securities laws, typically applied by the SEC in these cases (SEC v. Howey Co., 328 U.S. 293). As noted, the jury's finding in this case contradicts the position taken by the SEC in its enforcement under similar and analogous fact patterns in this area over the past several years under the Howey test (see Practice Note, SEC Regulation of Digital Assets).

Update: On June 3, 2022, the court issued a ruling on plaintiffs' post-verdict motions on their claims alleging securities law violations and common law fraud regarding the sale of cryptocurrency-related products Hashlets, Hashpoints, HashStakers, and Paycoin. The court denied plaintiffs' motions as to the Hashlet, Hashpoint, and Hashstakers products but granted plaintiffs' motion for a new trial on Paycoin, reasoning that the "common enterprise" and "efforts of others" prongs of the Howey test were met as to that product, contrary to the findings of the jury. The court found:

The final determination of whether Paycoin was an investment security will be determined at retrial.

For further information on regulation of digital assets, see Practical Law's Virtual Currency and Digital Asset Regulatory Tracker. See also Practical Law's Blockchain Toolkit.