October 01, 2020
by Daniel M. Payne

On September 30, 2020, a New York federal judge agreed with the SEC that Kik Interactive Inc. sold its cryptocurrency, Kin, in an unregistered public offering that violated the federal securities laws.  The case had been one of the most hotly contested concerning the application of securities laws to the sale of cryptocurrency.  This Kik decision may guide the future sale of digital assets, along with the DAO Report, In re Munchee, and the preliminary injunction granted in SEC v. Telegram.

Although there were two "instructive, but distinct" prior decisions applying the Howey investment contract test to cryptocurrencies (SEC v. Telegram Group Inc., No. 448 F. Supp. 3d 352 (S.D.N.Y. 2020) and Balestra v. ATBCOIN LLC, 380 F. Supp. 3d 340 (S.D.N.Y. 2019)), the Court foud that it had "to decide this case without the benefit of direct precedent."  Still, the court's reasoning followed all prior precedent and guidance.  

Kik conceded that the issuance of Kin involved an investment of money, the first Howey prong.  The court then found that Kik was a "common enterprise," the second Howey prong, because the money was pooled into a single bank account, which was used to fund operations including the construction of its blockchain.  The success of the blockchain was critical to the success of Kin. Thus, the court found "horizontal commonality" was met under Revak v. SEC Realty Corp., 18 F.3d 81, 87 (2d Cir. 1994).  As the court held, "the key feature [of horizontal commonality]... is that investors' profits at any given time are tied to the success of the enterprise."

The court applied the third Howey prong as explained in United Hous. Found., Inc. v. Forman, 421 U.S. 837, 852 (1975): whether investors have "a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others."  The court was persuaded that this prong was met on the following grounds: 1) Kik statements promoting the potential for profit-making, 2) a planned secondary market, 3) uncapped purchases of Kin, 4) the planned consumptive use of Kin was not available at the time of sale, and 5) Kik kept 30% of the tokens which incentivized it to increase demand for Kin.  Without these efforts, the court reasonsed, Kin would be worthless.

The court also made two other important rulings, holding that the pre-sale and public sale were a single, integrated securities offering that could not be analyzed separately, and that "investment contract" was not unconstitutionally vague as applied to Kik.

The ruling came on the motions for summary judgment brought by both the SEC and Kik.  Due to the pandemic, oral argument was conducted via telephone in July.  The order requires the SEC and Kik to propose a judgment for injunctive and monetary relief by October 20.

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Blockchain technology utilizes a distributed digital ledger to record and track information, and can be leveraged to gain transparency and certainty in transactions ranging from cryptocurrency to supply chain tracking.  This blog provides information on the legal developments surrounding implementation of blockchain technology, with an initial focus on the financial services sector.