November 02, 2020

MONTH-IN-BRIEF: Business Litigation & Dispute Resolution

Mac R. McCoy, Sara Bussiere

Business Litigation

SEC Wins Second Recent Case Adding Precedent to the Securities Analysis of Digital Assets

By Teresa Goody Guillén

On September 30, 2020, the United States District Court for the Southern District of New York granted the U.S. Securities and Exchange Commission’s (SEC) motion for summary judgment against Kik Interactive Inc. (Kik) and denied Kik’s cross-motion for summary judgment.  The SEC challenged Kik's compliance with the federal securities laws in raising funds through simple agreements for future tokens (SAFTs), and Kik's 2017 public sale, valued at approximately $100 million, of Ethereum-based ERC20 tokens, known as Kin.  The court held that the undisputed facts show Kik offered and sold securities without a registration statement or exemption from registration, in violation of Section 5 of the Securities Act of 1933 (Securities Act).  

The court held that the SAFT and token distribution were two offerings that were integrated.  This is a different precedent than that of the Telegram case, in which the court held that the SAFT sale and token sale were part of a single-scheme and multiple stages in the same offering. It is noteworthy that neither court held that the SAFT converted into the token, but instead, analyzed the token and token sale as a separate transaction from the SAFT sale.

Both courts applied the investment contract analysis to the digital asset, known as the Howey test.  The Howey test is a multi-factor analysis comprised of:  (1) an investment of money (2) in a common enterprise (3) with a reasonable expectation of profits (4) based on the entrepreneurial or managerial efforts of others.  The parties did not dispute that the first factor existed—that there was an investment of money.  The court held that horizontal commonality existed and thus the second factor was met.  The court combined factors three and four and found that there was an expectation of profits based on the efforts of others.  A significant factor cited by the court was that consumption was unavailable at the time of the token distribution because no products or services were available at the time of launch.  The court concluded that the demand of Kin relied heavily on Kik’s entrepreneurial and managerial efforts and that it is undisputed that Kik had to be the primary driver of the ecosystem.  While both cases have limited precedential value, it is noteworthy that both the courts in Kik and Telegram stated that the network being operational at the time of launch is a significant factor as to whether there is an investment contract, and thus whether the cryptographic asset is a security.

Mac R. McCoy

United States Magistrate Judge, Middle District of Florida

Mac R. McCoy is a United States Magistrate Judge in the Fort Myers Division of the United States District Court for the Middle District of Florida.  Prior to his federal judicial appointment on July 1, 2015, Judge McCoy was a Shareholder in the National Trial and National Class Actions Practice Groups at Carlton Fields, P.A. in Tampa, Florida.

Sara Bussiere

Associate, Bayard

Sara E. Bussiere is an associate in Bayard’s Litigation Department. Sara concentrates her practice on corporate and commercial litigation in the Delaware Court of Chancery, Delaware Superior Court, and the United States District Court for the District of Delaware. Sara counsels clients concerning the General Corporation Law of the State of Delaware and Delaware’s alternative entity statutes. Sara has experience in a broad range of corporate matters, including fiduciary duty claims, corporate and alternative entity control disputes, advancement and indemnification claims, trade secret and noncompetition agreement disputes, and other breach of contract claims. Sara also has experience advising corporate entities in receivership or seeking dissolution.