Impact of SEC v. LBRY, Inc. on the Howey Test and the broader Crypto Industry
By Bill Wise
While LBRY’s court case loss against the SEC is an unfortunate event for the cryptocurrency industry, it is critical that we understand the new positions the Judge took regarding the 3rd prong of the Howey Test: “Expectation of profit derived from the efforts of others”.
The briefs of both the SEC and LBRY focused on two main points regarding the third prong of Howey. First, whether the statements the LBRY team made regarding the token price and its potential for appreciation could be classified as an economic inducement. And second, whether the business model and utility aspects of LBRY and its token prevented it from fulfilling the third prong of Howey. The SEC and existing caselaw has always focused on how the company held its sale out to the public, and whether marketing or company statements implied or outright mentioned the potential for appreciation of the supposed investment. LBRY’s defense consisted of arguing that the token was being purchased for the utility that the token offered the user, and that people purchased the LBC token for use within the ecosystem, not because they were expecting the token to increase in value. LBRY asserts that the LBC tokens purchased were for a consumptive purpose. Additionally, LBRY asserted that the few statements that were made regarding the price of the token were a small fraction of LBRY’s overall public statements and shouldn’t have been construed as enticement. In the final judgement the judge decided to focus on the LBC tokens that LBRY Inc. had pre-mined and held in the company’s wallets, while also maintaining that although the LBRY statements regarding token price were minimal, they still amounted to economic inducement. Regarding the pre-mined tokens, the judge reasons that “by retaining hundreds of millions of LBC for itself, LBRY also signaled that it was motivated to work tirelessly to improve the value of its blockchain for itself and any LBC purchasers.”[1] Meaning that even if a team was completely silent in its communication with the public regarding the LBC token, the court could still find that there was an expectation of profit from the efforts of others through the team’s holding of substantial amounts of project tokens. The judge also rejected the “utility token” argument by stating “Nothing in the case law suggests that a token with both consumptive and speculative uses cannot be sold as an investment contract”[2], “… I cannot reject the SEC’s contention that LBRY offered LBC as a security simply because some LBC purchases were made with consumptive intent”[3].
The big takeaways from this case are as follows:
1. Statements regarding the token price or its potential for appreciation are indicative of economic inducement of investors. The mere fact that the statements only make up a small percentage of a company’s overall messaging does not diminish the relevance of such statements in a Howey analysis.
2. A token’s utility does not counteract the potential speculative value of the token and the potential for it to be labeled as a security.
3. The mere fact that a company holds large amounts of its native token can in it of itself create an expectation of profit by the efforts of others, regardless of company messaging or disclaimers to the contrary.
The SEC’s victory over LBRY sets a dangerous precedent for the rest of the crypto industry. Crypto companies that want to avoid falling under the authority of the Securities Act will have to be even more diligent in how they conduct their operations, lest they find themselves a target for enforcement by the SEC.
[1] Sec. & Exch. Comm'n v. LBRY, Inc., No. 21-CV-260-PB, 2022 WL 16744741, at *6 (D.N.H. Nov. 7, 2022) [2] id. at 7 [3] id.