Federal Court Grants SEC Summary Judgment Against Video-Sharing Platform LBRY for Unregistered Crypto-Asset Securities | Practical Law

Federal Court Grants SEC Summary Judgment Against Video-Sharing Platform LBRY for Unregistered Crypto-Asset Securities | Practical Law

The United States District Court for the District of New Hampshire issued an order granting the SEC's motion for summary judgment against LBRY, Inc., a New Hampshire software company that offers a video-sharing service, for unregistered offering and sale of crypto-asset securities.

Federal Court Grants SEC Summary Judgment Against Video-Sharing Platform LBRY for Unregistered Crypto-Asset Securities

by Practical Law Finance
Published on 08 Nov 2022 • USA (National/Federal)
The United States District Court for the District of New Hampshire issued an order granting the SEC's motion for summary judgment against LBRY, Inc., a New Hampshire software company that offers a video-sharing service, for unregistered offering and sale of crypto-asset securities.
On November 7, 2022, the United States District Court for the District of New Hampshire issued an order granting the SEC's motion for summary judgment against LBRY, Inc., a New Hampshire software company that offers a video-sharing service, for conducting an unregistered offering and sale of crypto-asset securities, LBRY Credits (LBC). The SEC alleged in its complaint that LBRY sold LBC from at least July 2016 to February 2021 without filing a registration statement in violation of Sections 5(a) and 5(c) of the Securities Act of 1933, as amended (Securities Act).
The SEC alleged that LBRY received approximately $12.2 million in proceeds in US dollars and crypto assets from its sales of LBC, Bitcoin, and services from purchasers who participated in its offering. LBRY operates on the decentralized video-sharing platform Odysee. The platform gives viewers the opportunity to earn cryptocurrency for watching videos and creators earn LBC for their efforts.
In its motion for summary judgment, LBRY asserted that its offering was not a security and that the SEC did not give LBRY fair notice that it needed to register its offering. LBRY offered the following to support its position that the LBRY credit was not a security:
  • The credit was a utility token designed for use on the LBRY blockchain.
  • Some credits were acquired with the intention of using them rather than holding them as an investment.
The court held that as a matter of law, that under the Howey test, developed by the US Supreme Court in SEC v. W.J. Howey Co. decision, 328 U.S. 293 (1946) to determine whether certain transactions constitute investment contracts:
  • The LBC sold by LBRY were securities.
  • LBRY’s offer and sale of those unregistered securities violated Section 5 of the Securities Act.
The court reasoned that LBC were securities under the Howey test because the tokens involved:
  • The investment of money. The court held that case law does not support the contention that a token with consumptive and speculative uses can't be sold as an investment contract.
  • A common enterprise. The court concluded that LBRY credits were promoted by LBRY as an investment that would grow in value over time through the development of the LBRY Network.
  • An expectation of profits to be derived "derived from the entrepreneurial or managerial efforts of others." The court found that LBRY’s decision to reserve LBRY tokens for itself led purchasers the tokens “to expect that they too would profit from their holdings of LBC as a result of LBRY’s assiduous efforts.”
In addition, the court rejected LBRY's contention that it should apply the fair notice standard established under Upton v. SEC (75 F.3d 92, 98 (2nd Cir. 1996)), which prohibits the SEC from imposing sanctions for violations of securities law after a substantial enforcement change that was not reasonably communicated to the public. LBRY argued that, similar to Upton, LBRY lacked fair notice of the SEC's substantial change in its enforcement policy – specifically that sales of native tokens like LBC consummated outside of an initial coin offering (ICO) could constitute investment contracts under the Securities Act subject to the SEC's jurisdiction. The court reasoned that the application of the Securities Act to an issuer of digital tokens that did not conduct an ICO is not a substantial enforcement change based on a novel interpretation of the rule, but rather a straightforward application of Supreme Court precedent.
The fair notice defense – that fair notice that defendant's offerings were subject to the securities laws was not provided – has also been raised in SEC v. Ripple Labs, Inc., et al., 1:20-cv-10832-AT-SN (S.D.N.Y. Jul. 12, 2022) (see Practice Note, SEC Regulation of Digital Assets: Ripple Labs Litigation).
For detailed information on SEC regulation of crypto and digital assets, see Practice Note, SEC Regulation of Digital Assets.