Commission Prevails in Crypto Asset Action

Crypto assets are now a key focus for the Commission and a topic of interest to the public. While many have clamored for new regulations to govern the assets, that seems unlikely for at least the immediate future if not longer. This leaves regulators to apply existing law. It is perhaps more than ironic that as the agency applies time tested court decisions that many claim the rules being used are vague. Yet in many instances those rules are decades old and tie to decisions such as SEC v. Howey, 328 U.S. 293 (1946), the predicate for a recent grant of summary judgment in favor of the Commission in a crypto asset case. SEC v. LBRY, Inc., Civil Action No. 1:21-cv-00260 (D.N.H.).

Defendant LBRY, Inc. is a privately owned firm based in Manchester, New Hampshire. It was created in 2015 to distribute digital content. It began with video distribution as a possible competitor for YouTube, Amazon and other video platforms.

To move forward with its vision LBRY claimed it would use blockchain technology by: 1) creating a “protocol” or set of rules for the transfer of data between devices; 2) create a user application; 3) make the necessary software to enable the protocol; 4) recruit those necessary for the video; and 5) attract consumers. To support these efforts the firm proposed to sell LBC – LBRY Credits.

The financing effort began in March 2016 with an announcement on the company website about the program. By June 2016 the firm launched its protocol having designed the first 400 million LBC in its possession. This constituted 40% of the total allowable supply under the protocol.

The LBC were then divided into three funds: The Operational Fund; the Community Fund; and the Institutional fund. Each fund was used slightly differently to achieve the overall goal. For example, the Community Fund focused on consumers; the Institutional Fund looked to institutions for partnerships, grants, donations and similar matters; and the Operational Fund looked to profit.

Beginning in 2016 the company offered LBC from the Community Fund in exchange for contributions to the network. At various points over a three-year period beginning in 2017, LBC from each of the other funds were offered to investors. Those investors purchased LBC in return for U.S. currency, bitcoin or other consideration such as services. The reason for the purchases was an expectation of profits from the pooling of their funds with others. The profits would come from the efforts of Defendant.

Following these transactions LBRY continued to sell LBC. About 10 million LBC were sold to retail investors. In late June the firm took steps to stabilize the price of LBC which varied significantly. In October 2020 the company represented on its website that LBC will only gain value as the use of its Network increased. Efforts to deliver on the promises made to investors continued in March 2021.

The LBC are not registered with the Commission. The complaint alleges violations of Securities Act Sections 5(a) and 5(c).

In moving for summary judgement the Commission relied on the Howey test. Its papers alleged that about $12.2 million in U.S. dollars and crypto assets had been raised from the sale of the assets. Those crypto assets were in fact an investment contract within the meaning of the Supreme Court’s ruling.

The Court agreed. In a Memorandum granting the Commission’s request for summary judgment the Court found that “what the evidence in the record discloses is that LBRY promoted LBC as an investment that would grow in value over time through the company’s development of the LBRY Network. . .” — an investment contract. Remedies will be considered at a later date. See Lit. Rel. No. 25573 (November 7, 2022).

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