On November 7th, a U.S. District Court judge ruled in favor of the Securities and Exchange Commission in SEC v. LBRY Inc., finding that the LBRY Credit (LBC) token was an unregistered security.
The judge cited several reasons for this ruling:
- LBRY marketed LBC as an investment
- LBRY’s financial success was tied to the value of LBC
- The SEC gave LBRY fair notice that its activity was unlawful, and
- Even though some investors used LBC for consumptive purposes (or, as is often said in the crypto industry, the token had “utility”), its economic realities qualified it as a security under the Howey Test
The SEC’s complaint against LBRY
In its March 2021 complaint, the SEC accused LBRY of selling digital asset securities called LBC tokens to numerous investors, including investors based in the US. The complaint alleged that LBRY did not file a registration statement for the offering, and that the offering failed to satisfy any exemption from registration. The complaint also identified multiple statements from LBRY that, according to the SEC, led potential investors to reasonably expect that LBC would grow in value.
The SEC alleged that these offerings violated sections 5(a) and (c) of the Securities Act of 1933.
LBRY Inc.’s argument
LBRY Inc. claimed that it did not offer LBC as a security and that it was not given fair notice that it needed to register its offerings. LBRY claimed that LBC functions as an essential component of the LBRY blockchain, and that the LBC token was a utility token because users had to use LBC in order to interact with services on the blockchain. Additionally, LBRY did not conduct an ICO and LBRY had already developed its blockchain before issuing its LBC token.
LBRY also asserted that the SEC’s attempt to treat LBC as a security violated its right to due process, because the agency did not give LBRY fair notice that its offerings of LBC were subject to securities laws.
The industry impact
This is perhaps the first time a federal court has found that a cryptocurrency sold outside of an Initial Coin Offering (“ICO”) is a security. It is also one of the first times a court has found that just because a cryptocurrency is used for “consumptive purposes” does not mean it is not a security. In other words, neither the absence of an ICO nor the existence of a utility is sufficient to distinguish a token as something other than a security.
Furthermore, while the judge acknowledged LBRY’s disclaimer that LBC was not an investment token, he ruled that a “disclaimer cannot undo the objective economic realities of a transaction.”
In a separate, ongoing case, the SEC has charged that Hydrogen’s HYDRO token is a security even though it was distributed through an airdrop, bounty programs, employee compensation schemes and direct sales. This may further set the precedent that tokens that aren’t sold as part of an ICO can still be considered securities.
The SEC’s growing remit over the crypto industry could have a significant impact on the types of compliance obligations expected of crypto companies and the number of enforcement actions filed against non-compliant ones. Since its first enforcement action against a crypto market participant in 2013, the U.S. SEC has been progressively increasing its oversight of the crypto industry; in our upcoming enforcement action report, we break down its main concerns.