New Jersey Federal Court Holds that Cryptocurrency Allegations Sufficiently Alleged a “Security” Subject to ’33 Act Registration Requirements
In Solis v. Latium Network, Inc., Susan D. Wigenton, a United States District Judge in the District of New Jersey, held that a class action plaintiff adequately alleged that a particular cryptocurrency was a “security” subject to the registration requirements of the Securities Act of 1933 and, by extension, the regulatory strictures of the Securities Exchange Act of 1934.
Solis alleged that Latium operates a blockchain-based, crowdsource tasking platform, which allows users to create tasks, find people to complete the tasks, and then verify completion of the tasks according to specified standards. Users of the platform pay for the completed tasks using Latium X tokens, Latium’s proprietary cryptocurrency, which can be used only on Latium’s platform.
Solis also alleged that, to raise money for the platform, Latium offered its tokens for sale to the public in exchange for U.S. dollars or the cryptocurrency Ether. The sale was conducted in several stages, with the cost of a token increasing with each successive stage. When marketing the tokens, Latium stressed the limited quantity of tokens to be issued and characterized its tasking platform, particularly in tandem with the tokens, as a “unique investment opportunity.”
Solis purchased $25,000 in Latium X tokens and later sued Latium in a class action, alleging that the Latium X tokens are “securities”—specifically investment contracts—under the 1933 Act and that Latium violated the Act by failing to register the tokens before it offered them for sale. Latium moved to dismiss the Complaint, arguing that its tokens are not investment contracts, or any other type of security, but instead are a functional currency allowing people to engage in transactions on its platform.
Judge Wigenton denied the motion. Relying on the United States Supreme Court decision in SEC v. Howey, Judge Wigenton identified three elements for an investment contract: “(1) an investment of money, (2) in a common enterprise, (3) with profits to come solely from the efforts of others.” Latium challenged only the second and third elements.
Solis alleged a “common enterprise,” according to Judge Wigenton, because he alleged that the funds raised through the sale of Latium tokens were pooled to develop and maintain Latium’s tasking platform and that one’s return on its investment in the platform was directly proportional to the number of Latium X tokens one purchased.
Judge Wigenton broke down the third Howey element into two questions: (1) did purchasers of Latium X tokens expect to make a profit or did they buy tokens so that they could purchase services over the platform and (2) if the purchasers expected a profit, were the expected profits to come “solely from the efforts of others.”
Relying on Latium’s marketing of the platform as a “unique investment opportunity” and the fact that at the time of the sale of the tokens the platform had limited functionality and was not in public use, Judge Wigenton concluded that Solis alleged enough facts to suggest that people who purchased the tokens did so to make a profit and not simply to acquire services through the platform.
Judge Wigenton also found that Solis had sufficiently alleged that any profits would be due principally to the efforts of Latium because Solis alleged that token purchasers relied entirely on Latium to, among other things, finance the platform by marketing the tokens and then build, market, and maintain the platform. Without those efforts by Latium, token purchasers could not expect to earn a return on their purchase of Latium tokens.
The Solis decision lends credence to SEC Chairman Clayton’s recent statement that whether a cryptocurrency is a security “depends on the facts.” The Solis decision was driven by the unique circumstances of the Latium tasking platform and its proprietary tokens. Whether other cryptocurrencies qualify as “securities” will “depend on the facts.”