Federal Court Orders New Trial to Determine Whether Cryptocurrency Is ‘Security’

A federal court recently overturned a jury verdict finding that a disputed digital asset was not a security and ordered a new trial to re-examine the matter. In November 2021, a federal jury in the District of Connecticut became one of the first to deliver a verdict on the frequently debated question of whether cryptocurrencies constitute “securities” under current securities laws. . The complainants in Audet v. Fraser had asserted five claims under state and federal securities laws against the director of a virtual currency developer, in connection with the company’s solicitation of cryptocurrency products. After an eight-day presentation of evidence, the jury returned a verdict in favor of the defendant, finding that none of the products constituted investment contracts and, therefore, that the four cryptocurrency products did not constitute securities.1

The plaintiffs later filed a motion for judgment as a matter of law and a motion for a new trial on the grounds that the jury’s findings violated the weight of the evidence. On June 3, 2022, the court dismissed motions regarding three of the disputed products, but granted a new trial to determine whether one of the products, Paycoin, qualifies as an “investment contract”.2 The decision highlights the continued development of this complex and fact-based cryptocurrency classification investigation, which remains a sharp focus of civil parties and the SEC in the cryptocurrency space.


The dispute in Audet involves the activities of GAW Miners, LLC (“GAW”), a company founded for the purpose of selling physical equipment that its customers could use to “mine” virtual currency. This business model allegedly proved unsustainable due to an insufficient supply of the promised material, and so GAW resorted to developing four new products to generate value for its customer base. The four new products were named “Hashlet” (a contract that gave buyers the right to a portion of GAW’s cryptocurrency mining profits), “Paycoin” (a new virtual currency), “Hashpoint” (tickets at order convertible into Paycoin) and “HashStaker” (digital wallets in which Paycoin could be stored). The Audet The plaintiffs, representing a class of individuals who had purchased these products, claimed that GAW’s business model amounted to a Ponzi scheme in which the company paid existing investors promised returns using profits generated from new sales of Hashlet. The plaintiffs filed lawsuits under state and federal securities laws, as well as common law fraud, against GAW, its CEO, a member of its board of directors who had invested in the company and another company that had helped develop the disputed products. . Prior to trial, both entities defaulted and GAW’s CEO was removed following a related guilty plea. The sole defendant director continued his lawsuit, where plaintiffs pursued a “control” theory of secondary liability under Section 20(a) of the Securities Exchange Act of 1934, a control person and claims aiding and abetting under the Connecticut Uniform Securities Act, and a claim for complicity in common law fraud.

Because the plaintiffs’ securities law claims required them to prove that one or more of the four products purchased by the class – Hashlets, Paycoin, Hashpoints or Hashstakers – constituted securities, the court ordered the jury to begin deliberations by considering this preliminary matter. The judgment in principle to determine whether a given product constitutes a “transferable security” is articulated in SEC vs. WJ Howey Co.; the four-part test is known as the “Howey Test”.3 Under the Howey Test, a court must determine whether the proceeds involve (1) an investment of money, (2) in a joint venture, (3) with a reasonable expectation of profit, (4) due to the efforts of others.4 With respect to the second prong, courts consider the product to involve a “joint venture” where there is either a “horizontal community” linking the fortunes of each individual purchaser to those of other purchasers by pooling their proposed assets, or a “vertical community” each linking the fortune of the individual buyer to the success of the business.

The jury concluded that none of the four products qualified as an “investment contract”. The verdict was considered notable in light of the fact that the investigator deviated from repeated warnings from the Securities and Exchange Commission (SEC) that certain cryptocurrency products may constitute securities under federal securities laws. securities.

District Court post-verdict decisions

After reviewing plaintiffs’ post-verdict motions, the court found that the jury’s verdict on three of the four disputed products – Hashlet, Hashpoint and Hashstaker – was not against the weight of the evidence.5 However, the court rejected the jury’s finding that Paycoin is not an investment contract and ordered a new trial regarding this product only. In laying out the basis for its decision, the court mainly focused its analysis on Hashlet and Paycoin only, as little evidence was presented regarding the other two products.6

The court focused its analysis of the “Hashlet” product, which provides buyers with shares of mining power in GAW mining farms, on the “joint venture” and “efforts of others” aspects of the Howey Test. With respect to the horizontal community dimension of the “joint enterprise” requirement, the court credited evidence indicating that Hashlet owners were made to expect to be able to select the “pool” in which the Hashlet was located. extracted on a given day, and therefore to make a profit. or suffer losses independently of other Hashlet owners.seven With respect to vertical community, the court determined that trial evidence supported the conclusion that GAW only made a profit from the acquisition of Hashlet and a lump sum royalty, and did not make any profits directly related to Hashlet mining.8 Finally, the court found that the evidence supported a conclusion that the plaintiffs had failed to establish the Hashlet owners’ reasonable expectation of profit primarily through the efforts of GAW. For example, the court explained, the jury could have reasonably concluded, based on the trial evidence, that Hashlet owners can exercise “meaningful investor control” by retaining control over the selection of their mining pools.9

The court reached the opposite conclusion with respect to Paycoin, finding that the “joint venture” and “efforts of others” prongs of the Howey test had been met, and that the jury’s finding to the contrary went against the weight some proof. Turning first to the concept of a horizontal community, the tribunal noted that GAW had encouraged sales of Paycoin – the price of which “went up and down in all areas” so that the gains or losses of Paycoin owners were proportional to their degree of ownership – to support the creation of a new digital ecosystem, the success of which would “drive demand” for cryptocurrency and thereby increase Paycoin’s value (and investor profits).ten Citing the case law of sister jurisdictions, the Court concluded that these facts were sufficient to support a finding of horizontal similarity.11 The court rejected the defendants’ argument that “hashpoints”, GAW’s internal cryptocurrency, did not constitute “assets” in this context because their rights were not “pooled” as are money or cryptocurrency, concluding that as long as the instruments contributed are owned and have value, they are considered “assets” so that there is a horizontal community.12

With respect to the “efforts of others” component, the court focused on GAW’s promotional material, which indicated that Paycoin differed from other cryptocurrencies due to GAW’s unique and significant financial, operational and marketing support. The court concluded that the “overwhelming” weight of evidence in the trial indicated that a reasonable buyer of Paycoin was motivated by these benefits, and “not by a desire to use Paycoin for consumption purposes.”13 The court dismissed defendant’s arguments to the contrary – which included, among other things, that unaffiliated users could mine Paycoin, that Paycoin used “open source” software, and that Paycoin was traded on public exchanges – as insufficient to refute his conclusion that Paycoin’s development and growth in value would depend on GAW’s efforts.14 The court therefore concluded that the weight of the trial evidence could not support a finding that the plaintiffs had failed to satisfy the Howey Test, and ordered a new trial with respect to Paycoin only.

Future Implications for Cryptocurrency Regulation

As the cryptocurrency market continues to grow in accessibility, especially during times marked by volatility and uncertainty, regulators, agencies, and courts will continue to grapple with how to classify and regulate these instruments. . While Paycoin’s ultimate fate will remain uncertain pending a new trial in Audet v. Fraserthe court’s decision underscores the likely continued proliferation of a fact-based, product-specific approach to the issue of cryptocurrency classification under securities law.

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