On November 27, 2018, Judge Gonzalo P. Curiel of the U.S. District Court for the Southern District of California denied a motion for preliminary injunction filed by the Securities and Exchange Commission (“SEC”) seeking to halt a planned initial coin offering (“ICO”) by a San Diego based company (the “Company”) and its owner in December 2018. SEC v. Blockvest, LLC
, et al.
, No. 3:18-cv-02287 (S.D. Cal Nov. 27, 2018) (the “Order”). Judge Curiel held that, due to disputed issues of material facts, and without full discovery, he could not determine whether the tokens issued by the Company constitute a “security” under the Securities Exchange Act of 1934.
On October 3, 2018, the SEC filed a complaint against the Company and its owner charging both with violations of securities registration and anti-fraud provisions under various provisions of the Securities Act of 1933 and Securities Exchange Act of 1934. Two days later, Judge Curiel granted the SEC’s motion for a temporary restraining order (“TRO”) against the Company. SEC v. Blockvest, LLC
, et al.
, No. 3:18-cv-02287 (S.D. Cal Oct. 5, 2018) (see also
Shearman & Sterling LLP, SEC
Obtains Temporary Restraining Order Halting Initial Coin Offering, Need-to-Know Litigation Weekly (October 16, 2018)). On November 16, 2018, the Court held an evidentiary hearing on the SEC’s motion for a preliminary injunction, where defendants presented evidence contradicting certain key facts from the SEC’s complaint. According to the SEC, the Company conducted pre-sales of a virtual token and planned to launch a $100 million ICO on December 1, 2018, and made numerous misstatements in the process. According to the Company, however, the pre-sale tokens were in fact “test tokens” that never sold publicly and were only issued to thirty-two testers who combined to put in less than $10,000 worth of Bitcoin and Ethereum. The Company claimed that the tokens were only designed for testing the platform and that testers would not be able to keep or remove the tokens from the exchange.
In denying the SEC’s motion for preliminary injunction, the Court found that the SEC failed to establish a prima facie case of previous violations of federal securities laws. Although there was no debate as to whether misstatements had been made, because the SEC and defendants “provide[d] starkly different facts as to what the [thirty-two] test investors relied on, in terms of promotional materials, information, economic inducements or oral representations at the seminars, before they purchased the test  tokens,” the Court found that it could not determine, at this stage, whether the pre-sale tokens were “securities.”
Judge Curiel’s decision highlights the challenges that the SEC faces when seeking injunctive and emergency relief to halt ICOs. The determination of whether an ICO meets the definition of a “security” is inherently fact-specific, making the government’s task more difficult given the limited discovery that typically will have taken place at the preliminary injunction stage. While this decision could be viewed as a setback for the SEC, which has found some success arguing that cryptocurrencies fall within the definition of “securities” (see
Shearman & Sterling LLP, Significant Judicial And Enforcement Developments In The Cryptocurrency Space
, Need-to-Know Litigation Weekly (September 18, 2018), Shearman & Sterling LLP, Criminal And Civil Charges Filed In Connection With Initial Coin Offering By Centra Tech
, Need-to-Know Litigation Weekly (April 10, 2018)), the fact-specific nature of the decision will also likely limit its reach.