SEC wins again on Howey token analysis this time against LBRY
In one of the few cases to address the application of the Howey test to blockchain-based assets, on November 7, 2022, the US District Court for the District of New Hampshire granted summary judgment to the SEC in an enforcement action alleging that defendant LBRY, Inc.’s LBC tokens constituted securities, which were sold without registration in violation of Section 5 of the Securities Act.
As outlined by the District Court in its opinion, LBRY developed LBC as the native token for the LBRY Network, which was to function as a decentralized blockchain-based distribution platform to allow sharing of videos, images, and other content. LBC was used to compensate miners as well as serve as a medium of exchange on the network. It could be spent to publish content, create "channels" that associate content with a user, tip content creators, purchase paywall content, or boost search results. In general, users must pay a fee in LBC to interact with the network for anything beyond viewing free content.
The underlying LBRY blockchain launched in 2016, and LBRY reserved a pre-mine of 400 million LBC (out of an anticipated one billion circulating supply). It distributed much of this to various recipients to support adoption and development of the network and sold LBC to fund its own operations.
In March 2021, the SEC filed an enforcement action against LBRY, alleging violations of sections 5(a) and (c) of the Securities Act. After discovery, the parties cross-moved for summary judgment, the main dispute being whether LBRY constitutes a security.
The court granted the SEC’s motion and denied LBRY’s, finding as a matter of law that LBC constitutes a security under Howey. As in prior cases (specifically Kik and Telegram), the decision came down to whether LBRY’s offering led investors to have a "reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others."
In finding this element of Howey satisfied, the court concluded that:
- LBRY made myriad statements that LBC would grow in value as the company continued development of the LBRY network
- LBRY made statements emphasizing the investment purpose of LBC
- LBRY’s business model, including retention of substantial LBC for itself, turned on its ability to grow the value of LBC by increasing usage of the LBRY Network
- The fact that some holders purchased LBC with consumptive intent did not preclude finding this Howey element as a matter of law
The application of Howey to blockchain-based assets remains the most important hotly debated legal issue in the field. While the SEC has published a Framework for "Investment Contract" Analysis of Digital Assets, the guidance on the crucial fourth Howey prong includes dozens of factors, none of which are independently dispositive. It remains, however, unclear how and where the SEC or a court might apply this Framework to conclude that a fungible token falls outside of Howey (though at least some individuals at the SEC have suggested this is the case for Bitcoin and Ethereum and some of the No-Action letters issued by the staff of the SEC to provide guidance).