California District Court Reverses Course, Grants Preliminary Injunction in Crypto Case Alleging Section 17 Violation After Initially Denying Such Injunction

Skadden, Arps, Slate, Meagher & Flom LLP

SEC v. Blockvest, LLC, No. 3:18-cv-02287-GPC-MSB (S.D. Cal. Feb. 14, 2019)

Judge Gonzalo P. Curiel granted the Securities and Exchange Commission’s (SEC) motion for partial reconsideration of the court’s November 2018 order denying a preliminary injunction against Blockvest for violating Section 17(a) of the Securities Act. In its original November 2018 order, the court found that the SEC had failed to make the requisite showing that Blockvest’s “BLV” tokens were “securities” under the federal securities laws because there was insufficient evidence that Blockvest’s early test investors had invested money in the tokens with an expectation of profits. After the SEC moved for reconsideration, however, Judge Curiel granted the motion for preliminary injunction, holding that the SEC had sufficiently established a prima facie case that Blockvest’s promotional materials concerning the initial coin offering (ICO) of its BLV tokens constituted an offer of unregistered securities in violation of
Section 17(a).

To obtain a preliminary injunction, the SEC first had to establish a prima facie case of a violation of federal securities laws. Here, the SEC alleged that Blockvest violated Section 17(a) by offering unregistered securities.

In analyzing whether the SEC sufficiently made the requisite showing for purposes of a preliminary injunction, the court first addressed whether the SEC had made out a prima facie case that the BLV tokens constitute “securities” within the meaning of the federal securities laws. Section 2(a)(1) of the Securities Act defines “security” to include, inter alia, “any note, stock, treasury stock ... bond ... [or] investment contract.” 15 U.S.C. § 77b(a)(1). The district court employed the U.S. Supreme Court’s three-part test from SEC v. W.J. Howey Co., 328 U.S. 293 (1946), to determine if the BLV tokens could be considered an “investment contract.” That 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. The district court emphasized that, “[i]n determining whether a transaction constituted a ‘security’ based on an offer and/or sale to investors, the Ninth Circuit looks to the specific promotional materials presented to the ‘investors.’” The court also recalled the Supreme Court’s guidance in SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 352-53 (1943): “The test [for determining whether an instrument is a security] ... is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect.” 

Here, as to the first Howey requirement, the court found that BLV tokens were an investment of money because the evidence presented indicated that the company’s website and the white paper the company posted online invited potential investors to exchange currency for BLV. With regard to the second Howey requirement, the Blockvest promotional materials that the SEC submitted to the court described BLV as a common enterprise, wherein funds from the tokens would be pooled and distributed according to a profit-sharing formula. As for the third Howey requirement, the court determined on the record before it that the profits of BLV were to come solely from the efforts of others because the company’s website and white paper sought “passive” investors and claimed that the tokens would generate “passive income.” Given the statements in the specific promotional materials that the defendants had presented to investors, the court held that the SEC had met its burden at the preliminary injunction stage to show that BLV tokens were a security, and that Blockvest’s website, white paper and social media posts concerning the ICO of the BLV tokens constituted an “offer” of unregistered securities, in violation of Section 17(a).
This summary can be found in the March 2019 issue of Inside the Courts.