A California federal judge had a change of heart regarding whether Blockvest’s initial coin offering (ICO) qualifies as a security. U.S. District Judge Gonzalo Curiel of the Southern District of California had previously rejected the Securities and Exchange Commission’s (SEC) request for an injunction.

SEC’s Allegations Against Blockvest ICO

In October, the SEC filed a Complaint against Defendants Blockvest, LLC and Reginald Buddy Ringgold, III a/k/a Rasool Abdul Rahim El alleging that the defendants violated federal securities law by offering and selling alleged unregistered securities in the form of digital assets called BLV’s via an ICO.

According to the SEC’s complaint, Blockvest and Ringgold promoted the tokens by falsely claiming their ICO has been “registered” and “approved” by the SEC and that their ICO has been approved or endorsed by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). In addition to utilizing the official logos and seals of the SEC and CFTC, the Defendants also created a fictitious regulatory agency, the Blockchain Exchange Commission (BEC), creating its own fake government seal, logo, and mission statement that are nearly identical to the SEC’s seal, logo and mission statement.

While Judge Curiel previously froze assets linked to the purportedly fraudulent ICO, he initially refused to grant the SEC’s request for a preliminary injunction. Judge Curiel found that the SEC had failed to demonstrate that the BLV tokens purchased by the 32 test investors were “securities” as defined under the securities laws. In reaching his decision, Judge Curiel relied on the so-called “Howey Test.” In SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946), the Court defined “investment contract” as a contract, transaction or scheme in which (i) a person invests money in a common enterprise; (ii) with a reasonable expectation of profits; (iii) to be derived from the entrepreneurial or managerial efforts of others. 

According to Judge Curiel, the SEC failed to satisfy the second prong because it did not demonstrate that the 32 test investors had an “expectation of profits.” He wrote, “While Defendants claim that they had an expectation in Blockvest’s future business, no evidence is provided to support the test investors’ expectation of profits.” Judge Curiel added: “Merely writing ‘Blockvest’ or ‘coins’ on their checks is not sufficient to demonstrate what promotional materials or economic inducements these purchasers were presented with prior to their investments.”

Court Grants Preliminary Injunction

Following Judge Curiel’s decision, the SEC moved for partial reconsideration, arguing that the court committed clear error on both prongs to support a preliminary injunction. First, the SEC argued that it was error for the court to require the agency to prove that an investment is a security based solely on the beliefs of some individual investors, rather than the objective nature of the investment being offered to the public. Second, it argued that the court also erred on the second factor based on Defendants’ promise not to commit any future securities fraud.

The SEC also offered a separate theory to support its request for a preliminary injunction. The SEC alleged, in the alternative, that the promotional materials concerning the ICO of the BLV token constitute an “offer” of unregistered “securities,” that contain materially false statements and thus, constitute violations of Section 17(a) of the Securities Act of 1933. In its memorandum in support for reconsideration, the SEC argued:

The Opinion [by the Court] appears to require proof of actual purchases and sales in order to show that the tokens at issue are securities. But it would subvert the purpose of the Securities Act if the SEC were required to show that specific investors relied on offering materials, to establish that an investment is a security. Such a requirement would effectively limit the SEC’s jurisdiction to claims only for illegal sales, not fraudulent offers.

On February 14, 2019, Judge Curiel granted the SEC’s motion for reconsideration. “The Court finds reconsideration is warranted based upon a prima facie showing of Defendants’ past securities violation and newly developed evidence which supports the conclusion that there is a reasonable likelihood of future violations,” he wrote.

Judge Curiel specifically found that the promotion of the ICO of the BLV token was a “security” and satisfies the Howey test. With regard to the first “investment of money” prong, Judge Curiel found that the defendants’ website and Whitepaper invited or enticed potential investors to provide digital or other currency in exchange for BLV, citing the  inclusion of a “Buy Now” button. He went on to find that the website promoted a “common enterprise” because Blockvest claimed that the funds raised will be pooled and there would be a profit sharing formula.

Judge Curiel also sided with the SEC with regard to whether the wrong was likely to be repeated. In its prior order, the court concluded that the wrong would not be likely repeated because Ringgold recognized that mistakes were made and he intended to comply with the securities law and stated in a declaration that he had ceased all efforts to proceed with the ICO. This time around, Judge Curiel found that the SEC presented a prima facie case of violations of Section 17(a), which creates an inference that the defendants will likely violate the securities law in the future if not enjoined. He also noted that Ringgold’s attorneys terminated their relationship with him after he sought to file documents that were not in compliance with Rule 11.

Key Takeaway

The court’s reversal highlights that the law surrounding ICO’s is not clear cut and continues to evolve. As it does so, the SEC will continue to take an aggressive stance, even if it means returning to court a second time to advance new legal theories.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.