On July 11, 2023, Judge Paul J. Barbadoro of the US District Court for the District of New Hampshire issued a final judgment in favor of the Securities Exchange Commission (SEC) in its cases against LBRY Inc., a blockchain-based content-sharing platform. After the court issued its order granting the SEC’s request for an injunction and requiring LBRY to pay a fine, LBRY took to Twitter to announce that it would spend the next several months winding down the company. Additionally, LBRY announced that it would not take further legal action in connection with the case and therefore would not be appealing to the US Court of Appeals for the First Circuit.

Background

Previously, in 2022, Judge Barbadoro granted the SEC’s motion for summary judgment and denied LBRY’s based on his conclusion that “no reasonable trier of fact could reject the SEC’s contention that LBRY offered LBC (its native token) as a security, and LBRY [did] not have a triable defense that it lacked fair notice” that it needed to register its offerings. 

LBRY then filed a motion to limit the SEC’s remedies and argued for a nominal civil penalty of $50,000 given the circumstances of the case. The SEC responded seeking three forms of relief: (1) a permanent injunction against both LBRY and its wholly-owned subsidiary Odysee; (2) disgorgement of any profits LBRY made through unregistered securities offerings; and (3) a civil penalty equal to LBRY’s “gross pecuniary gain.”

Then, following limited discovery related to LBRY’s financials, the SEC filed a supplemental brief withdrawing its request for disgorgement and limiting its request for a civil penalty to $111,614. In addition, the SEC’s proposed final judgment would have enjoined LBRY from violating § 5 of the Securities Act and pursuant to § 21(d)(5) of the Exchange Act, from participating in any unregistered crypto asset securities offerings. The SEC’s proposed injunction would also have bound any person or entity within the scope of Federal Rule of Civil Procedure 65(d). LBRY did not object to the modified civil penalty in its response but continued to insist that an injunction was not appropriate. LBRY then proposed a final judgment wherein it asked the court to: (1) find that the injunction against it did not apply to its subsidiary Odysee or any other user of LBC; (2) clarify its summary judgment order that “did not find that LBC tokens were ‘securities’ in and of themselves”; and (3) omit the provision enjoining LBRY from participating in any unregistered crypto asset securities offerings.

The Permanent Injunction

Judge Barbadoro’s final opinion began by addressing the parties’ arguments as to the permanent injunction. Here, the court assessed the appropriateness of the injunction as a means to prevent future violations of the statutory securities laws under four factors: (1) the egregiousness of the violation; (2) the degree of scienter; (3) the isolated or repeated nature of the violations; and (4) the sincerity of defendant’s assurances against future violations. 

The court gave three main reasons for its conclusion that “[t]he totality of these factors justifies issuing an injunction against LBRY to prevent future violations of securities laws.” First, the court noted that while LBRY’s actions did not constitute fraud, its violations of the laws were nevertheless “more egregious than a mere unregistered offering.” The court explained that not only did LBRY sell pre-mined LBC, but it also used its position as a market maker, was aware of LBC’s potential value as an investment, and “made sure potential investors were too.” Second, LBRY continued offering unregistered securities “in some form even after the lawsuit was filed and the SEC’s position on the registration requirement became clear.” Third, the court noted LBRY never acknowledged the “unlawfulness of its conduct.” The court concluded that “whether considered individually or in combination, these factors demonstrate a reasonable likelihood of future violations.” 

However, the court agreed with LBRY that the SEC did not present sufficient evidence to enjoin its subsidiary Odysee. Nevertheless, the court declined to hold that the injunction could not be applied to Odysee at a future date if it were to engage in conduct that “would bring it within the scope of Rule 65(d).

As to third-party holders of LBC, because the SEC expressly stated it was not seeking an order prohibiting all third parties from buying or selling LBC, “it suffices to say that merely holding LBC or purchasing it for consumptive purposes is insufficient to bring third parties within the purview of Rule 65(d). Instead, third parties would need to act in concert with LBRY in order to be exposed to a risk of being held in contempt of the injunction order.”

While Odysee and third-party holders of LBC escaped unscathed for now, the court ultimately enjoined LBRY from violating § 5 of the Securities Act and from participating in unregistered offerings of crypto asses securities in the future.

The Civil Penalty

The SEC asked the court to impose a civil penalty of $111,614, which is at the high end of  “first-tier” Securities Act penalties, while LBRY continued to argue for a nominal first-tier penalty of $50,000. Ultimately, the court sided with the SEC and found a maximum statutory amount penalty was appropriate because, although there were no allegations of fraudulent activities, “LBRY’s misconduct continued after the SEC’s position on the registration requirement became clear,” and “its violation [was] more egregious than a simple unregistered offering.” According to the court, the penalty will serve to deter LBRY and others from conducting unregistered offerings but also takes into account LBRY’s claims that it lacks the funds to pay a larger fine.

Final Thoughts

In the wake of the post-SEC v. Ripple euphoria that has gripped the crypto community during the past week, the SEC’s overall success here against LBRY may fly under the radar but has a few potentially important implications. 

First, the “major questions doctrine” Coinbase recently brought into the spotlight during its own legal battle with the SEC remains largely untested as a defense against SEC overreach. In footnote 2, the court rejected LBRY’s argument that the “major questions doctrine” foreclosed the SEC’s efforts to regulate digital assets because this argument “should have been raised earlier in the case, especially since the cited Supreme Court case was decided before [he] held oral argument on the cross-motions for summary judgment.” This was not a rejection of the potential application of the “major questions doctrine,” so much as the court chastizing LBRY and its counsel for forfeiting the argument by failing to raise it in its opening brief. 

Second, token issuers still need to be careful about marketing their assets as investments, and judges remain skeptical that crypto-native companies will abide by their promises to discontinue unlawful activity. Companies like LBRY can say whatever they want, but if they do not at least acknowledge their unlawful conduct and make a concerted attempt to discontinue it, courts will probably continue issuing injunctions at least in part because of “a reasonable likelihood of future violations.”

In light of ongoing regulatory uncertainty and the increasing frequency of enforcement actions by the SEC, it’s more important than ever to consult with legal experts well-versed in digital assets. Consulting with the lawyers here at Kelman PLLC early on is the most efficient way to ensure compliance with potentially applicable laws and regulations, and avoid legal pitfalls and expenses that could otherwise handicap your business

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