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The Howey Test for Investment Contract Analysis of Digital Assets

New York

,

United States of America

Issue

Are cryptocurrencies considered to be securities for the purposes of securities regulations?

Conclusion

Under Section 2(a)(1) of the Securities Act, the definition of "security" includes an "investment contract." The Howey test is used to determine what constitutes an investment contract. Under the Howey test, an investment contract for purposes of the Securities Act means 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 Howey test requires: (i) an investment of money; (ii) in a common enterprise; (iii) with profits to be derived solely from the efforts of others. (Securities and Exchange Commission v. Howey Co, 15 U.S.C. § 77b, U.S. Sec. & Exch. Comm'n v. Kik Interactive Inc.)

In 2019, the SEC published its “Framework for ‘Investment Contract' Analysis of Digital Assets" (the "Framework"), which provided a framework for analyzing whether a digital asset is an investment contract and whether offers and sales of a digital asset are securities transactions. The Framework is derived from the Howey test. (Framework for “Investment Contract” Analysis of Digital Assets, Williams v. Kucoin, In re Bibox Grp. Holdings Ltd. Secs. Litig.)

The Howey test is a fact-intensive inquiry, the result of which depends on the unique characteristics of each token. (In re Bibox Grp. Holdings Ltd. Secs. Litig.)

That said, in Atwal v. NortonLifeLock, Inc. the United States District Court for the Western District of New York held that a public sale of cryptocurrency is a sale of securities regulated under the Securities Act.

In 2019, the Securities and Exchange Commission ("SEC") concluded that EOS (a crypto-asset listed for trading on the Bibox exchange) was a security under the 1933 Securities Act. (In re Bibox Grp. Holdings Ltd. Secs. Litig.)

In Barron v. Helbiz Inc., the United States District Court for the Southern District of New York held that Helbiz Coin, the cryptocurrency at the center of the case, was a security.

In U.S. Sec. & Exch. Comm'n v. Kik Interactive Inc., the Court held that the sale of Kin (the cryptocurrency at issue) to the general public was an offering of securities.

Law

Section 2(a)(1) of the Securities Act, codified at 15 U.S.C. § 77b(a)(1), defines a "security" as:

(a) Definitions

When used in this subchapter, unless the context otherwise requires-

(1) The term "security" means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

[...]

In U.S. Sec. & Exch. Comm'n v. Kik Interactive Inc., 492 F.Supp.3d 169 (S.D. N.Y. 2020) ("Kik Interactive"), the United States District Court for the Southern District of New York explained that under Section 2(a)(1) of the Securities Act, the definition of "security" includes an "investment contract." The Howey test is used to determine what constitutes an investment contract. Under the Howey test, an investment contract for the purposes of the Securities Act means 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 Howey test requires: (i) an investment of money; (ii) in a common enterprise; (iii) with profits to be derived solely from the efforts of others:

"Section 5 [of the Securities Act] provides that it is unlawful for any person to use the channels of interstate commerce to sell a security unless a registration statement is in effect as to such security." SEC v. Verdiramo , 890 F. Supp. 2d 257, 268 (S.D.N.Y. 2011) ; see also 15 U.S.C. § 77e. "To prove a violation of Section 5 requires establishing three prima facie elements: (1) That the defendant directly or indirectly sold or offered to sell securities; (2) that no registration statement was in effect for the subject securities; and (3) that interstate means were used in connection with the offer or sale." SEC v. Universal Express, Inc., 475 F. Supp. 2d 412, 422 (S.D.N.Y. 2007); see also SEC v. Cavanagh, 445 F.3d 105, 111 n.13 (2d Cir. 2006). With respect to the sale of Kin to the public (the TDE), the only disputed legal issue is whether the was the sale of a "security"; the parties agree that all other elements under Section 5 are met.

Under Section 2(a)(1) of the Securities Act, the definition of "security" includes an "investment contract." 15 U.S.C. § 77b(a)(1). In determining what constitutes an investment contract, courts rely on the test set forth in SEC v. W.J. Howey Co.: "[A]n investment contract for purposes of the Securities Act means 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." 328 U.S. 293, 298-99, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946); see also Revak v. SEC Realty Corp. , 18 F.3d 81, 87 (2d Cir. 1994) ("three elements of the Howey test" are "(i) an investment of money (ii) in a common enterprise (iii) with profits to be derived solely from the efforts of others"). In this analysis, "form should be disregarded for substance and the emphasis should be on economic reality." Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967).

Few courts in this Circuit have had the opportunity to apply Howey in the context of cryptocurrency. The Second Circuit has not yet spoken on the issue, and two district court decisions, while instructive, present important distinctions in their facts. See SEC v. Telegram Group Inc., No. 448 F. Supp. 3d 352 (S.D.N.Y. 2020) (granting preliminary injunction to prevent planned distribution of digital tokens because there was a substantial likelihood that SEC would succeed in proving that plan constituted unregistered securities offering); Balestra v. ATBCOIN LLC , 380 F. Supp. 3d 340 (S.D.N.Y. 2019) (denying motion to dismiss in putative class action alleging that company sold unregistered securities through offering of digital tokens). I have to decide this case without benefit of direct precedent in relation to cryptocurrencies. I do so, understanding that the definition of investment contract is "a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." Howey, 328 U.S. at 299, 66 S.Ct. 1100.

In Williams v. Kucoin, 20-CV-2806 (GBD) (RWL) (S.D. N.Y. 2021), the United States District Court for the Southern District of New York noted that in 2019, the Securities and Exchange Commission ("SEC") published its Framework for “Investment Contract” Analysis of Digital Assets (the "Framework"), which provided a framework for analyzing whether a digital asset is an investment contract and whether offers and sales of a digital asset are securities transactions. The Framework is derived from the Howey test and sets out four prongs that are considered in determining whether a digital asset is a security. First, a party must make an investment of money or other valuable consideration. This prong is typically satisfied in an offer and sale of a digital asset. Second, the investment must be in a “common enterprise,” which also typically exists in the offer and sale of a digital asset “because the fortunes of digital asset purchasers have been linked to each other or to the success of the promoter's efforts.” Third, investors must have a “reasonable expectation of profit.” Fourth, the profits are expected to be “derived from the efforts of others” (at 3-4):

On April 3, 2019, the SEC published its “Framework for ‘Investment Contract' Analysis of Digital Assets, ” in which it “provided a framework for analyzing whether a digital asset is an investment contract and whether offers and sales of a digital asset are securities transactions” (the “SEC Framework”).[3] (Am. Compl. ¶ 99.) The SEC Framework is derived from the Supreme Court's “Howey test,” which defines an “investment contract” under the securities law 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.” Securities and Exchange Commission v. W. J. Howey, Co., 328 U.S. 293, 298-99, 66 S.Ct. 1100, 1103 (1946).

The SEC Framework sets forth four prongs that are considered in determining whether a digital asset is a security. First, a party must make an investment of money or other valuable consideration. According to the SEC, the first prong is typically satisfied in an offer and sale of a digital asset. (Am. Compl. ¶¶ 101-02.) Second, the investment must be in a “common enterprise, ” which also typically exists in the offer and sale of a digital asset “because the fortunes of digital asset purchasers have been linked to each other or to the success of the promoter's efforts.” (Am. Compl. ¶¶ 101, 104.) Third, investors must have a “reasonable expectation of profit.” (Am. Compl. ¶¶ 101, 107.) Fourth, the profits are expected to be “derived from the efforts of others.” (Am. Compl. ¶¶ 101, 114.) As alleged by Williams, “the Framework identifies a series of factually intense questions underscoring ... the challenges a layperson

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would face in analyzing whether a digital asset constitutes a security.” (Am. Compl. ¶ 109.) Indeed, the Amended Complaint's description and listing of the various characteristics to be assessed spans more than seven pages of the Amended Complaint. (Am. Compl. ¶¶ 109, 114, 118, 119.)

The Framework was also discussed by the United States District Court for the Southern District of New York in In re Bibox Grp. Holdings Ltd. Secs. Litig., 20cv2807 (DLC) (S.D. N.Y. 2021) (at 9-11):

A complex patchwork of federal and state laws regulates the issuance and sale of securities. These statutes include the Securities Act of 1933 (the "1933 Act"), 15 U.S.C. § 77a et seq., and the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. § 78a et seq. But these regulations apply only to investment products that qualify as securities under these statutes. For the purpose of federal law, a "security" is defined as, inter alia, an "investment contract." 15 U.S.C. § 77b(a)(1). The Supreme Court has 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." S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). This analysis, which is commonly called the Howey test, may be applied to determine whether a given investment product qualifies as a security and is thereby subject to a number of

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federal regulations applicable only to covered securities. Revak v. SEC Realty Corp., 18 F.3d 81, 87 (2d Cir. 1994).

Bibox claims that the BIX token, as well as the five other tokens at issue in this litigation, are not securities under the Howey test. Similarly, the issuers of the five tokens not issued by Bibox have each claimed that its tokens are not securities under this legal standard.2 The issuers also did not register the tokens as securities with the SEC.

On April 3, 2019, the SEC published a Framework for Investment Contract Analysis of Digital Assets (the "Framework"), which "provided a framework for analyzing whether a digital asset is an investment contract and whether offers and sales of a digital asset are securities transactions." In this Framework, the SEC essentially provided a gloss on the Howey test that applied the Howey analysis to crypto-assets. The Framework provides a means of assessing whether purchasers of crypto-assets invested money, participated in a common enterprise, expected profits, and expected that those profits would be solely derived from the managerial efforts of others, as set forth in Howey. With respect to the "expect[ed] profits" and "profits solely from the efforts of [another]" elements of Howey, the Framework sets forth lengthy non-exhaustive lists of

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characteristics of crypto-assets that should be considered in assessing whether a given crypto-asset satisfies those elements of the Howey test.

The Court explained that the Howey test is a fact-intensive inquiry, the result of which depends on the unique characteristics of each token (at 18):

Additionally, the issue of whether a particular token is in fact a security has significant consequences for each of the claims alleged in the complaint, and that determination involves an application of the Supreme Court's Howey test. That test is a fact intensive inquiry and will reach a result that depends on the unique characteristics of each token. Thus, even for the five tokens built on the ERC-20 platform and sold on the Bibox exchange, some may be covered securities and others not.

In the recent decision of Atwal v. NortonLifeLock, Inc., No. 20-CV-449S (W.D. N.Y. 2022), the United States District Court for the Western District of New York held that a public sale of cryptocurrency is a sale of securities regulated under the Securities Act (at 7-9):

Despite Defendant's argument (cf. Docket No. Def. Reply Memo. at 4 & n.3), if not regulated by the Federal Deposit Insurance Corporation cryptocurrency may be traded as securities or commodities, U.S. Sec. & Exch. Comm'n v. Kik Interactive Inc., 492 F.Supp.3d 169, 177-82 (S.D.N.Y. 2020) (securities); Williams v. KuCoin, No. 20-CV-2806,

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2021 WL 5316013, at *2 (S.D.N.Y. Oct. 21, 2021) (Lehrburger, Mag. J.) (Report & Rec.) (in 2019, Securities and Exchange Commission issued “Framework for ‘Investment Contract' Analysis of Digital Assets” stating four prongs in determining whether a digital asset was a security); see In re Bibox Group Holdings, supra, 534 F.Supp.3d at 331 (in 2019, the SEC concluded that EOS issued by Block.one was a security under the 1933 Securities Act); Commodity Futures Trading Comm'n v. McDonnell, 287 F.Supp.3d 213, 228 (E.D.N.Y. 2018) (Weinstein, J.) (commodities) (Docket No. 9, Pl. Memo. At 8, 9 & n.5). In CFTC v. McDonnell, Judge Jack Weinstein held that

“Virtual currencies can be regulated by CFTC as a commodity. Virtual currencies are ‘goods' exchanged in a market for a uniform quality and value. Mitchell Prentis, Digital Metal: Regulating Bitcoin As A Commodity, 66 Case W. Res. L. Rev. 609, 626 (2015). They fall well-within the common definition of ‘commodity' as well as the [Commodity Exchange Act's]] definition of ‘commodities' as ‘all other goods and articles ... in which contracts for future delivery are presently or in the future dealt in.' Title 7 U.S.C. § 1(a)(9).” Id. (emphasis added).

Securities regulation arises in the cited cases from the public sale of digital assets, Kik Interactive, supra, 492 F.Supp.3d at 174, 177-82; In re Bibox Group Holdings, supra, 534 F.Supp.3d at 331; Williams, supra, 2021 WL 5316013, at *2; see also 15 U.S.C. § 77e(a) (prohibition of sales in interstate commerce or the mails of unregistered securities). In Kik Interactive, defendant Kik Interactive conducted a private initial offering of Kin tokens with advice to buyers that the instrument they purchased was a security but not registered under any nation's securities laws, Id. at 181-82. The district court held that the private pre-sale of the Kin tokens was a part of an integrated offering followed by the public sale of the tokens, 492 F.Supp.3d at 181-82. The court concluded that this

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private pre-sale and public offering of defendant's Kin tokens was a public sale of securities requiring a registration statement, Id. at 177-82.

This conclusion, that a public sale of cryptocurrency is the sale of securities regulated under the Securities Act, however, postdates Plaintiff's present claim and occurred during the time of Defendant's denials of coverage. There is no allegation here of any public purchase or sale of Plaintiff's EOS cryptocurrency or public registration of the cryptocurrency. Plaintiff alleges his EOS cryptocurrency is a private asset not in a government-regulated account, declaring that he “maintained a private EOS cryptocurrency account” (Docket No. 1, Ex. A, Compl. ¶ 7). Defendant's Policy insured traditional currency accounts held by recognized institutions rather than the novel and evolving area of cryptocurrencies.

In In re Bibox Grp. Holdings Ltd. Secs. Litig., 20cv2807 (DLC) (S.D. N.Y. 2021), the United States District Court for the Southern District of New York noted that, in 2019, the SEC concluded that EOS (a crypto-asset listed for trading on the Bibox exchange) was a security under the 1933 Securities Act (at 6-7):

The EOS token is a crypto-asset that was created by the issuer Block.one and initially offered for sale in June 2017. EOS has been listed for trading on the Bibox exchange since December 3, 2017. Block.one described EOS as a technologically superior competitor to Bitcoin and Ethereum. Like BIX, EOS was

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created via a centralized process, rather than through the decentralized mining process used to create Bitcoin and Ethereum.

In 2019, the Securities and Exchange Commission ("SEC") concluded that EOS was a security under the 1933 Securities Act. The SEC further found that Block.one had violated the 1933 Securities Act by selling EOS as an unregistered security. Block.one paid a $24 million settlement to the SEC for its securities law violations related to its sale of EOS. Block.one is not a defendant in this litigation.

In Barron v. Helbiz Inc., 20 Civ. 4703 (LLS) (S.D. N.Y. 2021), the United States District Court for the Southern District of New York held that Helbiz Coin (the "token"), the cryptocurrency at the center of the case, was a security. The Court found that the token met the Howey test definition of an investment in a common enterprise, from which the investor was led to expect profits primarily from the efforts of a third party. The economic reality was that buyers of the token in the initial coin offering ("ICO") expected they would profit from the tokens' value rising along with demand as Helbiz used revenue from the ICO to grow its transportation platform and promote token use. The token's admittedly trivial use as a transportation fare was dwarfed by its promotion, purchase, and use as an investment product (at 3-9):

Helbiz Coin (the "token"), the cryptocurrency at the center of this case, is a security.

The Securities Act of 1933, 15 U.S.C. § 77b(a)(1), and the Securities and Exchange Act of 1934, 15 U.S.C. § 78c(a)(10), both include "investment contract" in their definitions of the term "security." The United States Supreme Court has defined "investment contract":

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In other words, an investment contract for purposes of the Securities Act means 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, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.

S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). That definition "embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." Id. at 299.

Helbiz Coin satisfies the Howey definition. Defendants treated the token as an investment from its inception. The Helbiz Coin Whitepaper's discussion of the initial coin offering ("ICO") states

In order to further develop the platform, Helbiz will conduct a token generation event that will offer 520.000.000 HBZ tokens of the 1 billion total supply. The funds raised will be used for development of the Helbiz platform, business development; onboarding new car owners, rentals, dealerships, collaborate with insurance and PR & Marketing companies to raise project awareness, token usability while at the same time building a strong local community.

Helbiz Mobility System Whitepaper, Ex. J to Plaintiffs' Motion for Preliminary Injunction, at 17. Helbiz and its CEO Salvatore Palella described how the Helbiz transportation platform and the token were a common enterprise:

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- "We are now only focused on launching and scaling operations, creating value for early investors and the #HBZ coin." Id. ¶¶ 87, 124.

- "Helbiz is focused on the long term success of HBZ and therefore the team [is buying] $1m (USD) of HBZ on the open market, paired with additional large buy walls on the main exchanges, to strengthen the company's position both internally and to new investors #Helbiz." Id. ¶ 120(I) (alteration in original).

They also worked to get the token listed on various cryptocurrency exchanges:

A. The tweet from PALELLA on May 31, 2018: "May has come to an end. @Helbizofficial is more attainable and launched on 11 exchanges, finished our updated UI for our apps, acquired a new office in NYC and will now focus on the press aspect globally. #hbz #Helbiz."

B. The tweet from PALELLA: "Eventful first 60 hours of the week, with our third exchange of the week - @Helbizofficial will list on @hitbtc!" This included a response from Defendant PELLEGRINO: "Impressive"

C. Postings to PALELLA's personal facebook page: "Happy to be in #London for the launch of @Helbizofficial $HBZ (4/26) in the exchange";

D. "Helbiz is now listed on its first exchange!";

E. "We are happy to partner with Anthony Diorio and his team listing Helbiz on Jaxx.io";

F. "Proud of my Helbiz team. I love the Jaxx.io integration. ExchangeS (sic) coming soon!" and a link to an article "Helbiz HBZ token integrated into Jaxx Multicurrency Digital Wallet";

G. "Helbiz is now live and listed on bonus exchange Mercatox with a Top 10 exchange listing coming soon!";

H. "It is now 1 month since Helbiz got listed, and today 30 days later Helbiz is traded on 11 exchanges and 26 markets globally. With product launch getting

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closer I am excited for the next couple of months! #HBZ #Helbiz #HelbizP2P #HelbizPay";

I. Also, @Helbizofficial tweeted in November of 2018: "We are working on listing one [of] Jaxx's large partner exchanges."

See id. ¶¶ 120. And plaintiffs constantly call themselves investors in the complaint (33 times) and describe the defendants' program as a "pump and dump" investment scheme:

This action is brought to obtain justice for approximately 20,000 small investors who were swindled in a crypto currency scam called HelbizCoin perpetrated by Defendants PALELLA and HELBIZ INC. ("HELBIZ"). The scam preyed mainly on small, unsophisticated investors, with the average investment being approximately $2,000. But by leveraging the exponential messaging capacity of social media worldwide, and by creating purposeful misimpressions about the size of the company and the popularity of the investment, Defendants were able to trick thousands of people and extract over $40 million dollars by an initial coin offering ("ICO") and by later dumping the coins on the secondary market.

Complaint ¶ 2. The token was an expected source of profit on resale, and its purchase was a classic "laying out of money in a way intended to secure income or profit from its employment." Howey, 328 U.S. at 298.

While Helbiz Coin was initially sold as both a method of paying transportation fare and an investment product, when Helbiz repeatedly delayed adopting the token as its exclusive payment method, it became increasingly clear that the token was in fact an investment. After promoting Helbiz Coin as the

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"native token for Helbiz transactions," the company stalled the integration of the token into its platform:

55. HELBIZ also changed its story about the role that the HelbizCoin would play. First, it announced plans to expand HelbizCoin's use case far beyond transportation to restaurants and online shopping and in point of sale terminals with retailers world wide. This was bunk, intended to soften the blow of the rest of the announcement.

56. Simultaneously with announcing these new ambitions for the coin, HELBIZ said that it had redesigned the platform so that it did not use HelbizCoin.

57. HELBIZ tried to justify the announcement with doubletalk to the effect that it was supposedly acting in the best interest of the coin holders by delaying its promise to make HelbizCoin the platform's currency because taking fiat currency instead of HelbizCoin would drive adoption of the platform and thereby (allegedly) increase the value of HelbizCoin when HELBIZ switched the platform over to HelbizCoin at a future date.

58. The company announced that the switch from fiat to HelbizCoin would now happen in a fourth phase of the development, Helbiz V4.0: "In the 4th phase Helbiz will utilize its user base, previous growth and position within local communities to phase out direct fiat payments in the Helbiz app moving towards a crypto only solution. All purchases, even with credit card, will simply purchase HBZ of the open market via the exchange API to fill the in-app wallet which will only hold HBZ making it the only accepted currency." (Compl. ¶s)

When Helbiz eventually began accepting the token, "it was in parallel with fiat prices, not exclusive as promised, and did not get much use as a result." Id. ¶ 66. Helbiz then abandoned the notion that the Helbiz Coin would

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be its exclusive payment method, while the token's value plummeted.

Speaking of Helbiz's planned destruction of the token, Helbiz engineer Carlos Beltran tweeted "I'm a lead engineer at HELBIZ and can say a thing or 2 about the matter - I integrated HBZ as a partner payment solution. We didn't see enough usage of HBZ @hbzcoin as trip payments, and therefore discontinued the partnership." Id. ¶ 115.

The economic reality is that buyers of Helbiz Coins in the ICO expected they would profit from the tokens' value rising along with demand as Helbiz used revenue from the ICO to grow its transportation platform and promote token use. The token's admittedly trivial use as a transportation fare was dwarfed by its promotion, purchase and use as an investment product, just as the buyers of tracts of land for citrus cultivation in Howey had "no desire to occupy the land or to develop it themselves; they are attracted solely by the prospects of a return on their investment." 328 U.S. at 300.

The Helbiz Coin is an investment in a common enterprise, from which the investor was led to expect profits primarily from defendants' entrepreneurial efforts. Its use as a fare for transportation was insignificant. "If that test be satisfied, it is immaterial whether the enterprise is speculative or non-

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speculative or whether there is a sale of property with or without intrinsic value." Id. at 301.

From any point of view, the Helbiz Coin is a security.

In Kik Interactive, supra, the Court held that the Howey test was satisfied for Kin (the cryptocurrency at issue). Issuance of Kin through transparent data encryption involved an investment of money. The common enterprise requirement was satisfied by investors reaping profits in the form of the increased value of Kin. The third requirement, that there was an expectation of profits to be derived from the efforts of others, was satisfied by the fact that Kik (the creator and seller of Kin) was the primary driver of the ecosystem that drove demand for Kin (at 177-180):

Kik concedes that its issuance of Kin through the TDE involved an investment of money by which participants purchased

[492 F.Supp.3d 178]

or acquired Ether and exchanged Ether for Kin. Thus, the parties agree that the first element of the Howey test is satisfied. The parties dispute whether the second and third elements are satisfied. I hold that that they are.

A. Common Enterprise

"A common enterprise within the meaning of Howey can be established by a showing of ‘horizontal commonality’: the tying of each individual investor's fortunes to the fortunes of the other investors by the pooling of assets, usually combined with the pro-rata distribution of profits." Revak, 18 F.3d at 87.5 Where horizontal commonality is present, "the fortunes of each investor depend upon the profitability of the enterprise as a whole." Id.

Kik established a common enterprise. Kik deposited the funds into a single bank account. Def. 56.1 Resp. ¶ 295. Kik used the funds for its operations, including the construction of the digital ecosystem it promoted. See infra Part II.B; Def. 56.1 Resp. ¶¶ 296-99. This ecosystem was crucial. The success of the ecosystem drove demand for Kin and thus dictated investors’ profits. Kik recognized and repeatedly emphasized this. Rather than receiving a pro-rata distribution of profits, which is not required for a finding of horizontal commonality, investors reaped their profits in the form of the increased value of Kin. See Balestra, 380 F. Supp. 3d at 354 ("[F]ormalized profit-sharing mechanism" in the form of pro-rate distribution "is not required for a finding of horizontal commonality.").

Kik, relying primarily on out-of-circuit authority, seeks to create additional requirements for a common enterprise. It is true, as Kik asserts, that in the Terms of Use Agreement, Kik expressly disclaimed any ongoing obligation to TDE purchasers after the distribution of their Kin. However, an ongoing contractual obligation is not a necessary requirement for a finding of a common enterprise. See Davis v. Rio Rancho Estates, Inc., 401 F. Supp. 1045, 1049-50 (S.D.N.Y. 1975) (considering contractual obligations among other representations, or lack thereof, in assessing common enterprise prong). For example, in Hart v. Pulte Homes of Michigan Corp.,

Alexsei publishing date:
2022-03-03 17:16:33.573066
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