Co. Can’t Duck Claims $17M ‘Tokens’ Were Unregistered Stock
Law360, December 10, 2018
A New Jersey federal judge on Monday refused to toss a putative class action against a company that operates a blockchain-based tasking platform, leaving intact an investor’s claims that Latium Network Inc. unlawfully raised more than $17 million by selling unregistered securities in the form of cryptocurrency called LatiumX tokens.
U.S. District Judge Susan D. Wigenton denied Latium’s bid to dismiss Joevannie Solis’ complaint, finding that he has sufficiently alleged that the tokens are “investment contracts” under the test set by the U.S. Supreme Court’s 1946 SEC. v. W.J. Howey Co. opinion.
“Because the LATX tokens were never registered with the Securities and Exchange Commission … plaintiff may maintain a cause of action against Latium under Section 12 of the act,” Judge Wigenton said in her written opinion, referring to the Securities Act of 1933.
“Defendants’ arguments to the contrary are better suited to support a motion for summary judgment,” the judge added.
In addition to Latium, the company’s co-founders, David Johnson and Matthew Carden, are named as defendants in the suit. Given those executives’ positions and public statements during Latium’s “initial coin offering,” Solis has presented enough facts to support “a controlling person claim” against them, Judge Wigenton said.
The Latium platform enables users to create tasks and pay others to complete those tasks in exchange for LATX tokens, court documents state. Between July 25, 2017, and March 1, 2018, Latium conducted the initial coin offering in which investors bought the tokens with either U.S. dollars or the cryptocurrency “Ether,” court documents state.
On Jan. 12, Solis took part in the initial coin offering and purchased 208,333.33 LATX tokens for $25,000, court documents state. Nearly five months later, Solis launched the proposed class action, alleging the defendants sold unregistered securities in violation of the Securities Act of 1933.
In seeking to dismiss the suit, the defendants contended in part that the tokens are not securities subject to registration requirements, saying in a brief that the tokens are “the digital currency that users of the Latium platform send and receive as payment for completing tasks of the Latium platform, not a method of investment in the Latium platform.”
“LATX Tokens are designed to allow users to pay and receive payments from all over the world, without the necessity to exchange currencies,” the brief states. “As a currency, LATX is exempt from the Securities Act.”
But Judge Wigenton concluded Monday that the tokens met the three-prong Howey test for being an investment contract. Howey defined an investment contract as “a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
The defendants acknowledged that the first prong — an investment of money — is satisfied since U.S. dollars or Ether were used to purchase the tokens, Judge Wigenton said.
As for the second prong — investing in a common enterprise — such an enterprise “can be established by showing ‘horizontal commonality,’ which ‘is characterized by a pooling of investors’ contributions and distribution of profits and losses on a pro-rata basis among investors,’” the judge said, citing the Third Circuit’s 2000 U.S. SEC v. Infinity Grp. Co. opinion.
The judge pointed to Solis’ allegations that the money raised through the initial coin offering was pooled to develop and maintain the tasking platform and allocated for different purposes, and that an investor’s return is directly proportional to the investor’s financial stake and amount of tokens.
“At this early stage of litigation, plaintiff has sufficiently pled the existence of horizontal commonality,” Judge Wigenton said.
Under the third prong, investors must be drawn to the investment by the possibility of turning a profit instead of a desire to use or consume a purchased item, and those profits must solely come from others’ efforts, the judge said.
The complaint outlined various ways in which the defendants led investors to expect a profit from buying the tokens, the judge said. For example, the defendants had referred to the initial coin offering as a “‘unique investment opportunity’ that would ‘generate better financial returns[.],'” the judge said.
“These factual allegations support the inference that plaintiff purchased LATX tokens with the expectation of profit rather than as a means of using the tasking platform,” Judge Wigenton said.
Solis also has asserted that investors were “completely dependent on defendants to market the ICO, raise funds to finance the tasking platform, manage those funds, develop and build the tasking platform, market the platform, maintain LATX’s listing on cryptocurrency exchanges for active trading, and ultimately maintain the platform,” the judge added.
“Thus, plaintiff has adequately alleged that any potential return on his investment in LATX tokens would have primarily resulted from defendants’ efforts,” the judge said.
Solis attorney Eric T. Kanefsky of Calcagni & Kanefsky LLP told Law360 on Monday in an email, “Judge Wigenton’s decision today … is a very important first step toward protecting both the investors in Latium and all cryptocurrency investors. While the prospects of this burgeoning industry are certainly exciting, companies must still comply with this country’s securities laws even when selling cryptocurrency products.”
Stefan Savic of Shipkevich PLLC, representing the defendants, said Monday in an email that Judge Wigenton “denied the motion finding that ‘[a]t this early stage of litigation,’ Plaintiff sufficiently pleaded the facts entitling to proceed with the case beyond the pleading stage.”
“According to the Court, ‘Defendants’ arguments to the contrary are better suited to support a motion for summary judgment,’” Savic noted. “I, respectfully, believe that even at this pre-answer stage, the Plaintiff’s allegations were insufficient to survive the motion to dismiss as there were plenty of facts demonstrating not only the utility of the LATX token, but also how owners of the LATX token intend to profit from using the token, not merely from owning the token. We remain confident in our position, and preserve our arguments for the motion for summary judgment, as instructed by the Court.”
Solis is represented by Eric T. Kanefsky, Samuel S. Cornish and Martin B. Gandelman of Calcagni & Kanefsky LLP, Klint Bruno and Michael Silverman of The Bruno Firm LLC and Aaron K. Dickey of Flint Law Firm LLC.
The defendants are represented by Stefan Savic of Shipkevich PLLC and Gene K. Kaskiw of Lewis Brisbois Bisgaard & Smith LLP.
The case is Joevannie Solis v. Latium Network Inc. et al, case number 2:18-cv-10255, in the U.S. District Court for the District of New Jersey.