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U.S. District Court Declines to Accept SEC’s Argument that Token is a “Security” Until It Can Resolve Disputed Questions of Fact

On November 27, 2018, the U.S. District Court for the Southern District of California issued a decision that is already being reported as one holding that a token is not a “security.”  That is incorrect.  The court left for another day the issue of whether the token in question meets the securities law definition of a “security.”  It merely held that, for purposes of the request for a preliminary injunction, the court could not conclude that the token at issue was a “security” because there were disputed issues of fact around whether there was sufficient evidence of an “offer” and an “expectation of profits.” Both are essential elements to the Securities and Exchange Commission (SEC) proving its case against the defendants.  The district court’s decision should therefore not be seen as making any change in the law concerning the SEC’s approach to security token determinations.

We previously reported about this case. According to the complaint, the defendant Blockvest not only falsely claimed that it had obtained SEC approval, it also used the SEC seal without permission (a violation of federal law), promoted the ICO with a fake agency called the “Blockchain Exchange Commission” (using a graphic similar to the SEC’s seal and the same address as SEC headquarters), and offered the tokens in an unregistered securities offering in violation of the securities laws.  When the SEC filed the lawsuit, it also obtained a temporary restraining order.  That was followed by additional briefing and a hearing.  Yesterday, the court rejected the SEC’s request for a preliminary injunction.

Blockvest Argues Preliminary Injunction is Inappropriate Because Its Token is Not a Security

Because the SEC is a governmental agency acting as a “statutory guardian charged with safeguarding the public interest in enforcing the securities laws,” the two-part test for obtaining a preliminary injunction requires the SEC to show “(1) a prima facie case of previous violations of federal securities laws, and (2) a reasonable likelihood that the wrong will be repeated.” In opposition, Blockvest challenged only the SEC’s claims that its tokens (BLV tokens) were “securities” as defined under the federal securities law.

In order the meet the first element of the preliminary injunction standard, the SEC had to establish a prima facie case that Blockvest’s activities violated the registration and anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. Blockvest claimed the SEC did not do this because it had not proven that the tokens at issue were a “security.”  Critically, without a finding that the tokens are a security, the SEC would not have jurisdiction over this matter and the case would need to be dismissed.  The well-established test for whether an investment contract is a security comes from the Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). Howey’s three-part test requires “(1) an investment of money (2) in a common enterprise (3) with an expectation of profits produced by the efforts of others.”

In granting Plaintiff’s ex parte TRO application, the court found that the SEC had presented a prima facie showing, based on Blockvest’s marketing and advertising through its websites and media posts of Blockvest and its ICO, that BLV tokens were “securities.”  Based on Blockvest’s postings on the internet, the SEC asserted that it raised more than $2.5 million from investors, there was a “common enterprise” because Blockvest claimed that the funds raised will be pooled and there would be a profit sharing formula. And, as described on its website and whitepaper, Blockvest investors would be passive would depend entirely on Blockvest’s efforts.

In opposition, Blockvest presented a different rendering of facts than the SEC. They explained that they did not raise $2.5 million from the public but instead the $2.5 million was supposed to be based on a transaction with one David Drake.  However, the transaction eventually collapsed and they admit the social media posts were overly optimistic.  They assert they have not sold any BLV tokens to the public but instead used the BLV tokens for purposes of testing during the development phase.  During this phase, 32 testers put a total of less than $10,000 of Bitcoin and Ethereum onto the Blockvest Exchange.  The BLV tokens were only designed for testing the platform and no tokens were released to the 32 testing participants.  In the future, they intended to issue a new utility Token BLVX on the NEM Blockchain for exclusive use on the Blockvest Exchange.  Moreover, Blockvest argued there is no common enterprise and the tokens do not represent an interest in or obligation of a corporation or other business.  Therefore, Blockvest argue the BLV token is not a “security.”

Court Holds Off Due to Disputed Issues of Fact

With respect to the first Howey factor, the court stated that “the focus on this ‘investment of money’ prong is ‘what the purchasers were offered or promised.’“  Perhaps foreshadowing its conclusion, the court went on to explain that a “[c]haracterization of the inducement cannot be accomplished without a thorough examination of the representations made by the defendants as the basis of the sale.  Promotional materials, merchandising approaches, oral assurances and contractual agreements were considered in testing the nature of the product in virtually every relevant investment contract case.” The court determined that the SEC and Blockvest provided starkly different facts as to what the 32 test investors relied on, in terms of promotional materials, information, economic inducements or oral representations at the seminars, before they purchased the test BLV tokens.  According to the court, because there are disputed issues of fact, it could not make a determination whether the test BLV tokens were “securities” under the first prong of Howey.

As to the “expectation of profits” prong of Howey, the court defined profits as “either capital appreciation resulting from the development of the initial investment . . . or a participation in earnings resulting from the use of investors’ funds.”  The court held that the SEC had not demonstrated that the 32 test investors had an “expectation of profits.”

The court said that, without full discovery and because there were disputed issues of material facts, it could not make a determination whether the BLV token offered to the 32 test investors was a “security.” Thus, Plaintiff has not demonstrated that the BLV tokens purchased by the 32 test investors were “securities” as defined under the securities laws. The court thus concluded that the SEC had not demonstrated a prima facie showing that there was a previous violation of the federal securities laws.

Court was also Satisfied that Further Violations are not Likely

The second part of the test for obtaining an injunction concerns whether the wrong will be repeated. The court noted that there was evidence that Blockvest’s founder, Buddy Ringgold, made misrepresentations shortly after the complaint was filed and prior to having retained counsel.  However, according to the court, after Ringgold retained counsel, he asserted that he would not pursue the ICO and will provide SEC’s counsel with 30 days’ notice in the event they decide to proceed.  Thus, the court held that the SEC had not demonstrated a reasonable likelihood that the wrong will be repeated.

Because the SEC could not satisfy the two-factor test to warrant a preliminary injunction, the court denied the motion for preliminary injunction.

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David Zaslowsky chairs the Litigation Department of Baker McKenzie's New York office, and practices in the area of general commercial litigation and arbitration. He is the editor of the Firm's blockchain blog and co-editor of the Firm's International Litigation & Arbitration Newsletter. David has a degree in computer science and has worked on numerous technical-related disputes. He has also worked on many cases involving issues of international litigation, including matters related to the Foreign Sovereign Immunities Act, enforcement of foreign arbitral awards, the Alien Tort Claims Act, forum non conveniens, obtaining discovery in aid of foreign proceedings under 28 U.S.C. Section 1782, and foreign attachments. David has been included for a number of years in the Chambers USA Guide and Chambers Global Guide for his expertise in International Arbitration.


Jerome Tomas is Chair of the Firm's SEC and Financial Institutions Enforcement Group and has been recognized by Chambers for White Collar Crime & Government Investigations. He represents multinational companies faced with government investigations and conducts internal investigations to assess and remediate legal and compliance concerns in domestic and global operations. With his experience as a former member of the SEC Division of Enforcement’s Cyberforce, the agency’s internet and cyber fraud unit, Jerome regularly advises companies involved in data security breaches and incident response. Jerome now leads teams of lawyers to address government law enforcement perspectives and where necessary, meet and refute government legal theories of corporate and individual liability head-on, while also being pragmatic and business-oriented for management and boards to compete internationally.


Ansley Schrimpf is a derivatives attorney in the Firm’s Global Derivatives and Hedge Fund practice. She regularly advises clients on a broad array of regulatory, transactional and enforcement matters involving the financial markets and financial products. Prior to joining Baker McKenzie, Ansley served in the general counsel department of the National Futures Association, where she advised on regulatory matters related to futures, forex and swaps, including provisional registration reviews of US and non-US swap dealers.


Patrick Dennien is an associate in the Compliance, Investigations, & Government Enforcement Practice Group in Washington, DC. Prior to joining Baker McKenzie, Mr. Dennien worked at the World Bank’s Integrity Vice Presidency as an integrity compliance specialist, where he assessed compliance conditions imposed on sanctioned parties by the World Bank. Mr. Dennien also advised parties sanctioned on the development and implementation of effective integrity compliance programs. Mr. Dennien began his legal career in Australia, where he practiced in administrative law and corporate litigation.