While the SEC continues to target fraudulent crypto-projects, we’ve seen a marked increase in the number of class actions targeting a wider-range of ICOs.[1] The crypto-industry is watching these cases intently; awaiting the judiciary’s play in the on-going game of “Are Crypto-Tokens Securities?”. Earlier this week, United States Magistrate Judge Andrea M. Simonton (Southern District of Florida) laid an early card in Rensel v. Centra Tech, Inc.[2] Although the Report and Recommendation[3] is not the in-depth analysis of a functional, utility-heavy token the industry desperately needs, it nonetheless offers some food for thought.

Analyzing the plaintiffs’ motion for a temporary restraining order, the court asked whether the plaintiffs had a likelihood of succeeding on the merits of their securities fraud claims. Part of that analysis involved applying the Howey Test[4] to determine whether Centra Token (“CTR”), the token powering Centra Tech’s purported “crypto-debit card” is a security. Judge Simonton had little trouble concluding that the token-purchasers met the first two Howey-prongs because the plaintiffs invested USD, Ether, and Bitcoin in an operation they had little control over. Moreover, “because the success of Centra Tech and the Centra Debit Card, CTR Tokens, and cBay that it purported to develop was entirely dependent on the efforts and actions of the Defendants,” the court also concluded that CTR satisfied the remaining Howey prong (that there be an expectation of profits derived solely from the efforts of others). Ultimately, Judge Simonton concluded that CTR meets the requirements of an investment contract and, thus, for now, the unregistered Centra Tech ICO could have violated the Securities Act of 1933.

However limited, Judge Simonton’s analysis is interesting for several reasons. First, the court focused on how the defendants’ efforts impacted the success of not just the CTR token, but also the products and applications operating around CTR, namely the cBay marketplace and the Centra Debit Cart.  Second, rather than inquiring whether the defendants themselves created an expectation of profits, the court was satisfied that such an expectation existed, regardless of its origin. Ultimately, the precedential value of this opinion is limited because the defendants conceded for the purposes of the motion that CTR are securities. In an industry searching for clarity, however, interested parties in all corners will undoubtedly rely on Rensel to make their respective points. With time and repetition, the contours of the Howey test as it applies to crypto-tokens will begin to take shape; whether other courts should follow the path laid in Rensel remains to be seen.

The parties have the opportunity to lodge objections to Judge Simonton’s Report and Recommendation before it is ultimately considered by United States District Judge James Lawrence King.

[1] See e.g., Jacob Zowie Thomas Rensel v. Centra Tech, Inc., No. 17-CV-24500 (S.D. Fla.); Coffey v. Ripple Labs Inc. et al., No. 3:18-cv-03286 (N.D.C.A.); GGCC LLC v. Dynamic Ledger Solutions Inc. et al., No. 5:17-cv-06779, (N.D. Cal.).

[2] Rensel, v. Centra Tech, Inc., No. 17-CV-24500, 2018 BL 227097 (S.D. Fla. June 25, 2018).

[3] A magistrate’s report and recommendation is subject to objections by both parties. After the parties object, the report and recommendation goes to the assigned district court judge who will make the final decision whether to reject, adopt, or adopt in-part the magistrate’s decision.

[4] Under the so-called Howey Test, a particular scheme is considered a security if it qualifies as an investment contract whereby a person [1] invests money in [2] a common enterprise and [3] is led to expect profits [4] solely from the efforts of the promoter or a third party.  SEC v. W.J. Howey, 328 U.S. 293 (1946). Although some courts apply this as a three-prong test, the same essential elements are required.