No SUPREME COURT OF THE UNITED STATES. THE CHARDIN NETWORK, AND FRANCIS BOUVIER, Petitioner,

Transcription

1 No SUPREME COURT OF THE UNITED STATES THE CHARDIN NETWORK, AND FRANCIS BOUVIER, Petitioner, v. HUNTER FOSS, Respondent. ON WRIT OF CERTIORARI TO THE SUPREME COURT OF THE UNITED STATES BRIEF FOR THE RESPONDENT Counsel for Respondent Team Number: R5 Fordham University School of Law 150 West 62nd Street New York, New York i Word Count: 7264

2 QUESTIONS PRESENTED I. Do Chard tokens satisfy the definition of a security as used in 15 U.S.C. 78j (2012) where they involve an investment of money in a common enterprise with a reasonable expectation of profits coming from the managerial efforts of others? II. Applying the second prong of Morrison, does liability under Section 10(b) of the Exchange Act extend to a transaction in which title was exchanged within the United States, the foreign issuer of the security was actively involved, and the rights and obligations of all parties were defined? ii

3 TABLE OF CONTENTS QUESTIONS PRESENTED TABLE OF CONTENTS TABLE OF AUTHORITIES STATUTES INVOLVED STATEMENT OF THE CASE 1 Procedural History 1 Statement of the Facts 2 SUMMARY OF ARGUMENT 8 ARGUMENT 10 I. CHARDS ARE SECURITIES BECAUSE THEY INVOLVE AN INVESTMENT OF MONEY IN A COMMON ENTERPRISE WITH REASONABLE EXPECTATION OF PROFITS TO COME FROM THE MANAGERIAL EFFORTS OF OTHERS. 10 A. Chard tokens involved an investment of money because they were purchased with digital or fiat currency. 11 B. The investment is a common enterprise because all investors shared the same risks and benefits of Chard ownership. 12 C. The white paper proves that token holders reasonable expectation of profits superseded their interest in purchasing Chards to use. 13 D. Profits came from the efforts of others because token holders did not have sufficient control over the Chardin Network. 16 II. THE TRANSACTION SATISFIES THE DOMESTICITY REQUIREMENT OF SECTION 10(B) OF THE EXCHANGE ACT 21 A. The Transaction Satisfies the First Prong of the Morrison Test 21 B. The transaction also satisfies the second prong of the Morrison test. 23 C. Petitioner s behavior is akin to that of an issuer of a sponsored ADR. 25 CONCLUSION 29 ii iii iv v iii

4 TABLE OF AUTHORITIES CASES Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 68 (2d Cir. 2012) Curran v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 622 F2d. 216 (6th Cir. 1980) Fargo Partners v. Dain Corp., 540 F.2d 912 (8th Cir. 1976)... 16, 18 Hirsch v. DuPont, 396 F. Supp 1214 (S.D.N.Y. 1975) Int'l Bhd. of Teamsters v. Daniel, 439 U.S. 551, (1979) Morrison v. Nat l Austl. Bank Ltd., 561 U.S. 247 (2010)... 2, 21, 23 Noa v. Key Futures, Inc., 638 F.2d 77 (9th Cir. 1980)... 19, 20 Parkcentral Glob. Hub Ltd. v. Porsche Auto. Holdings SE, 763 F.3d 198, 216 (2d Cir. 2014)... 24, 25 Pinker v. Roche Holdings Ltd., 292 F.3d 361 (3d Cir. 2002)... 28, 29 Reves v. Ernst & Young, 494 U.S. 56 (1990) SEC v. Belmont Reid & Co., 794 F.2d 1388 (9th Cir. 1986)... 16, 19 SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344 (1943) SEC v. Edwards, 540 U.S. 389 (2004) SEC v. Ficeto, 839 F. Supp. 2d 1101 (C.D. Cal. 2011)... 9, 22 SEC v. Glenn Turner Enters., Inc., 474 F.2d 476 (9th Cir. 1973) SEC v. SG Ltd. 265 F.3d 42, 44 (1st Cir. 2001) SEC v. SG Ltd., 265 F.3d 42, 54 (1st Cir. 2001) SEC v. Shavers, No. 4:13-CV-416, 2014 WL SEC v. W.J. Howey Co., 328 U.S. 293 (1946)... passim Sinva, Inc. v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 253 F. Supp. 359 (S.D.N.Y. 1966) Stoyas v. Toshiba Corp., 191 F. Supp. 3d 1080 (C.D. Cal. 2016)... 9, 25, 26, 27 Tcherepnin v. Knight, 389 U.S. 332 (1967) United Hous. Found., Inc. v. Forman, 421 U.S. 837 (1975)... 10, 11, 13, 16 Uselton v. Commercial Lovelace Motor Freight, Inc., 940 F.2d 564 (10th Cir. 1991) Williamson v. Tucker, 645 F.2d 404 (1981) STATUTES 15 U.S.C. 77b(a)(1) U.S.C. 78c(a)(1) (2012) REGULATIONS 17 C.F.R g3-2 (2008) OTHER AUTHORITIES MUNCHEE INC., 3 S.E.C , Securities Act Release No (Dec. 11, 2017) REPORT OF INVESTIGATION PURSUANT TO SECTION 21(A) OF THE SECURITIES EXCHANGE ACT OF 1934: THE DAO, Exchange Act Release No (July 25, 2017) S. REP. NO , at 6 (1934) iv

5 STATUTES INVOLVED SECURITIES EXCHANGE ACT OF 1934, 15 U.S.C. 78 et seq. (2012): It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange-- 78j(b). To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement[,] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. 78c(a)(1). When used in this title, unless the context otherwise requires... the term "exchange" means any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange. SECURITIES ACT OF 1933, 15 U.S.C. 77b(a)(1) (2012): 77b(a)(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, (emphasis added) 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. GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934, 17 C.F.R. 240 et seq. (2008) b-5. It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, v

6 (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security g3-2(ii). At a minimum, a foreign private issuer shall electronically publish English translations of the following documents required to be published under paragraph (b) of this section if in a foreign language: (A) Its annual report, including or accompanied by annual financial statements; (B) Interim reports that include financial statements; (C) Press releases; and (D) All other communications and documents distributed directly to security holders of each class of securities to which the exemption relates. vi

7 STATEMENT OF THE CASE Procedural History On September 1, 2017, Hunter Foss ( Respondent ) filed a complaint in the United States District Court of Fordham against the Chardin Network and Francoise Bouvier (collectively the Petitioners ) seeking $1.5 million in damages after Petitioners schemed to misrepresent the value of Chard tokens, a violation of Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act ). (R. at 8.) Respondent stated that Chard Tokens are securities as the term is used in Section 10(b), and that Respondent relied on Petitioners fraudulent and misleading statements when purchasing tokens. (R. at 8 9.) In response, Petitioners filed a Fed. R. Civ. P. 12(b)(6) motion on October 10, (R. at 9.) They claimed that Chards are not securities, and even if they were, Petitioners were not sufficiently involved in the domestic transaction where the Chards were sold to Respondent. (R. at 9.) The District Court granted Petitioners motion on October 27, 2017, finding that the complaint failed to state a claim upon which relief could be granted. (R. at 9.) Respondent timely filed an appeal to the Court of Appeals for the Fourteenth Circuit and argued that the District Court erred in holding that Chards are not securities under the investment contract test in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). (R. at 10.) Additionally, Respondent said that Petitioners were sufficiently involved in the token 1

8 transaction and that the domesticity requirement of Morrison v. Nat l Austl. Bank Ltd., 561 U.S. 247 (2010) was met. (R. at 10.) The Court of Appeals agreed and reversed the District Court s holdings on both issues. (R. at 17.) The Court found all four of the Howey prongs for an investment scheme satisfied; therefore the tokens meet the statutory definition of a security. (R. at 17.) The Court of Appeals also held that Respondent s purchase of Chard tokens from Pyrenees satisfies Morrison s domesticity requirement. (R. at 24.) Petitioners appealed and the Supreme Court of the United States granted certiorari on February 7, (R. at 36.) Statement of the Facts In 2015, Francoise Bouvier founded a French business called the Chardin Network, offering a cryptocurrency now called Chard tokens or Chards issued and maintained on a blockchain. (R. at 1.) When Bouvier decided to create a blockchain network, he contacted Sabrina Bernard, CEO and founder of the social media platform InforMe. (R. at 1.) InforMe is mainly used in France and allows users to share videos and articles with other users. (R. at 1 2.) But, InforMe requires users to watch many advertisements before they may post or view others content, and Bernard knew the ads dissuaded users from joining. (R. at 2.) She told Bouvier a digital token on a blockchain could help InforMe grow, so they together conceived the digital tokens called Chards, which could be earned by InforMe users by performing functions on the app. (R. at 2.) 2

9 Once earned, Chards could be spent to skip the pervasive advertisements and use premium content. (R. at 2.) Bouvier believed the tokens could be used on other social media sites as well. (R. at 2.) To fund the blockchain, Bouvier asked his close friend and mentor Marcel Lagadere for startup money. (R. at 2.) Lagadere offered to give 2 million to the Chardin Network s early funding, and suggested the Chardin Network have an Initial Coin Offering (ICO). (R. at 2.) After the ICO, Bouvier would hold 9% of Chards, Lagadere would hold 5%, the Chardin Network would keep 25% of Chards for users to earn, some early investors would have 10%, and the other 51% would be sold to the public. (R. at 2.) When Bouvier consented to the plan, Lagadere found ten wealthy people to pay 1 million for 1% of Chard tokens each; on October 15, 2016, the Chardin Network sold 10% of Chards to these early investors. (R. at 2 3.) To prepare for the ICO, Bouvier and Lagadere drafted a white paper promoting the network to token purchasers. (R. at 3.) On November 20, 2016 they posted the white paper on the Chardin network website. (R. at 3.) The white paper included sections on Corporate Governance Structure, Chard Token Utility, and Security Features of the Chardin Network. (R. at 3 5.) The Corporate Governance Structure section describes the management and control of the business. (R. at 3.) A seven-person leadership group (the Custodians ) is responsible for managing day-to- 3

10 day operations, maintaining the Chardin source code, and handling ordinary business transactions. (R. at 3.) Bouvier will hold one Custodian position, and the ten early investors select the other six by vote at the annual token holder meeting but they cannot themselves be Custodians. (R. at 3.) Bouvier can only be removed from his position by a majority vote of the other Custodians, but any other Custodian can be voted out for any reason. (R. at 3.) The white paper says this structure ensures that control over the future direction of the Chardin Network remains in the hands of the investors. (R. at 3.) It also says that the business hopes to attract people interested in tech and commerce, but does not mention any qualifications, skill, or experience that investors or Custodians need to have. (R. at 3 5.) The Chard Token Utility section states that Chards are utility tokens allowing token holders to use them on social media. (R. at 3 4.) Token holders also get voting rights if they purchase or earn their Chards, while tokens held by the Chardin Network do not have voting rights. (R. at 4.) There are a finite number of Chards that can be purchased or earned, and Chards spent on social media are returned to the Chardin Network so that other app users can earn them. (R. at 4.) This section also lays out the procedure for social media sites to contract for use of the blockchain source code on their platform. (R. at 4.) Any contract proposal that offers a price below 5 million ( Small Bid Contracts ) will be submitted to the Chardin Network Custodians. The Custodians reserve the right to review these contract proposals and 4

11 determine if a particular proposal will be put up to a token holder vote at the annual meeting. Any contract proposal in which a social media platform offers to pay more than 5 million ( Large Bid Contracts )... will go directly to a token holder vote. If submitted, token holders can vote to approve these Large Bid contract proposals through a portal on the Chardin Network website... Large Bid Contracts, therefore, circumvent any Custodian review. (R. at 4 5.) All contracts are posted for token holder review before any vote and if a majority approves, the Custodians must adapt the source code to work with the new social media platform. (R. at 5.) The Security Features of the Chardin Network describes protocol for a security breach. A three-person team (the Chardin Security Group ) investigates any breaches. (R. at 5.) They are required to report breaches to the Custodians immediately, who then must publicize the breach to the token holders in a quarterly report posted online and distributed. (R. at 5.) On the morning of the ICO, January 15, 2017, the head of the Chardin Security Group ed Bouvier warning him that 5 million worth of Chards were stolen from the blockchain. (R. at 5.) Though the stolen tokens were later recovered, Bouvier concealed the security breach from Lagadere, the other Custodians, and the entire public in direct breach of the Chardin Network s white paper statement. (R. at 5 6.) In spite of the undisclosed security breach, the ICO was a huge success with investors purchasing 150 million worth of Chards with fiat or digital currency. (R. at 6.) 60% of the ICO participants were registered 5

12 InforMe users, and the week after the ICO, Chards were selling on the secondary market at 23% above the ICO price. (R. at 6.) Over the next month, the Chardin Network received eight Small Bid proposals, including one from a South Asian social media site called MyBook. (R. at 6.) The Custodians and MyBook agreed that MyBook would get the code for free, and that this contract would be brought to a vote at the next token holder annual meeting. (R. at 6.) At that meeting, an overwhelming majority of token holders voted to approve the contract. (R. at 6.) The Custodians also reported that users spent or earned 15 million Chards on InforMe since the ICO. (R. at 6.) No Small Bid or Large Bid contracts have been submitted since the first annual meeting, but Chard prices soared on secondary markets. (R. at 6.) On June 7, 2017 (three months after the first annual meeting), Lagadere came to Pebble Beach, Fordham to visit Bouvier at his second home, where he often stayed while developing and working on the Chardin Network. (R. at 6.) While on the trip, Lagadere arranged a meeting with Madeline Mauriac, the CEO of Pyrenees, LLC ( Pyrenees ), a Fordham-based cryptocurrency brokerage firm. (R. at 7.) At the meeting, Lagadere said the Chardin Network s success was because they never had a cyberattack and the network was secure. (R. at 7.) He also wanted the business to move into United States social media platforms to increase the tokens value. (R. at 7.) Though Lagadere nor anyone else within the Chardin Network thought the Chards were 6

13 securities, the Custodians knew that selling in the United States complex regulatory environment was risky. (R. at 7.) Mauriac offered a solution: Pyrenees could buy a large portion of Chards and then re-sell them in a private token sale to investors in the United States. (R. at 7.) When Lagadere told Bouvier about his conversation with Mauriac, Bouvier encouraged Lagadere s entrepreneurship, but said that neither he nor the Chardin network should be involved in the Pyrenees transaction. (R. at 7.) But, he also said that he would not stop Pyrenees from purchasing the Chards. (R. at 7.) Lagadere later told Mauriac that Bouvier approved of their scheme, so Lagadere and Mauriac posted the Chardin Network white paper to the Pyrenees website to attract and inform American investors. (R. at 7.) Pyrenees purchased 8 million worth of Chards off of a French cryptocurrency exchange on July 29, (R. at 8.) At no point did Bouvier, Lagadere, Mauriac, or anyone involved with the Chardin Network communicate with the United States Securities and Exchange Commission ( SEC ). (R. at 7.) Less than one month later, on August 21, 2017, a major American newspaper, the Fordham Observer, received an anonymous package containing hard copies of the exchanges between Bouvier and the Chardin Security Group about the undisclosed cyber attack on the morning of the ICO as well as other attacks on the blockchain after the ICO. (R. at 8.) Bouvier never mentioned these attacks to anyone else at the Chardin Network or to the public, and they were never published in 7

14 the quarterly reports on the Chardin website. (R. at 6, 8.) When the Fordham Observer published the s, the value of Chards dropped by 85% within the next two days. (R. at 8.) Hunter Foss is a seventy-eight-year-old farmer and United States citizen from Fordham. (R. at 8.) He purchased $1.5 million of Chards from Pyrenees in an over-the-counter ( OTC ) market transaction on August 1, 2017 in reliance on the false and misleading information from the Chardin Network. The value of Foss s Chards similarly plummeted after August 21, (R. at 8.) SUMMARY OF ARGUMENT The Court of Appeals correctly held that Chards meet the definition of a security as used in Section 10(b) of the Exchange Act because they satisfy the four-prong test for investment contracts which are listed as an example of a security in the Securities Act. If Chards are investment contracts, then they are securities. Investment contracts require an investment of money in a common enterprise with a reasonable expectation of profits coming from the managerial efforts of others. Because the Chards were purchased with digital money, all investors are similarly exposed to benefits and risks, Chardin Network personnel induced token holders to buy Chards as an investment rather than for use, and token holders have very little managerial control of the company, Chard tokens satisfy all four-prongs of the Howey test for investment contracts. The Chardin Network Chard 8

15 token scheme thus satisfies the four-prong investment contract test as handed down in Howey. Since Chards are investment contracts, they are securities and Petitioners come within the ambit of Section 10(b). The Circuit Court correctly held that the sale of Chard tokens to Petitioner constituted a domestic transaction under the two-pronged test established in Morrison. The test provides that in order for a securities transaction to create liability under Section 10(b), it must have involved either (1) securities listed on domestic exchanges or (2) domestic transactions in other securities. The statutory language and legislative history of Section 10(b) of the Exchange Act support imposing liability to securities transactions on the domestic OTC market, satisfying the first prong of Morrison. SEC v. Ficeto, 839 F. Supp. 2d 1101, 1109 (C.D. Cal. 2011). The transaction also satisfies the second prong of the Morrison test, established by Absolute Activist and Parkcentral. Title to the Chard tokens was transferred within the United States and the transaction was not predominantly foreign. The court should reject the analogy to sales involving sponsored and unsponsored American Depositary Receipt ( ADR ) given the minimal difference between the two. Stoyas v. Toshiba Corp., 191 F. Supp. 3d 1080, (C.D. Cal. 2016). Even if the court does find the analogy useful, the relationship here established by the Chardin Network was functionally that of an issuer of a sponsored ADR. The Chardin Network 9

16 and Bouvier should not escape liability given their high degree of involvement in this transaction. ARGUMENT I. CHARDS ARE SECURITIES BECAUSE THEY INVOLVE AN INVESTMENT OF MONEY IN A COMMON ENTERPRISE WITH REASONABLE EXPECTATION OF PROFITS TO COME FROM THE MANAGERIAL EFFORTS OF OTHERS. The definition for a security as used in Section 10(b) of the Exchange Act is broadly defined in the Securities Act of 1933 (the Securities Act ). The Securities Act includes a list of over twenty examples of securities, and should encompass virtually any instrument that might be sold as an investment. Reves v. Ernst & Young, 494 U.S. 56, 61 (1990); 15 U.S.C. 77b(a)(1). Among the examples is the term investment contract which is not further defined by the Securities Act or any legislative reports, but is codified as a specific investment vehicle. SEC v. W. J. Howey Co., 328 U.S. 293, 298 (1946); 15 U.S.C. 77b(a)(1). The Supreme Court held in Howey that an investment contract, and therefore a security, exists where the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others. Howey, 328 U.S. at 301. This is now interpreted as a four-prong test where each element requires a separate analysis. Int'l Bhd. of Teamsters v. Daniel, 439 U.S. 551, 553 (1979); see e.g. United Hous. Found., Inc. v. Forman, 421 U.S. 837 (1975). However, the Supreme Court reanalyzed the last two prongs in United Housing Foundation v. Forman. Profits is now understood to mean a reasonable 10

17 expectation of profits, and solely from the efforts of others is interpreted more inclusively as deriving from the managerial or entrepreneurial efforts of others. Forman, 421 U.S. at 852. The current Howey test asks whether there is an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. Id. The Howey test is meant to be a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable investment schemes. Howey, 328 U.S. at 299. Therefore, substance is more important than form when determining whether something is a security. Tcherepnin v. Knight, 389 U.S. 332, 336 (1967). Crucially, the Howey test should examine the economic realities underlying [the] transaction and the scheme as a whole to determine whether an investment contract exists. Forman, 421 U.S. at 849; Howey, 328 U.S. at 298. This flexible and inclusive test provides the backdrop for this issue of first impression. A. Chard tokens were an investment of money because they were purchased with digital currency. The first prong of the Howey test requires an investment of money. Howey, 328 U.S. at 301. It is well established that an investment of money obviously includes but is not restricted to cash. See Uselton v. Commercial Lovelace Motor Freight, Inc., 940 F.2d 564, 574 (10th Cir. 1991). Significantly, Bitcoin investments were recently recognized as satisfying Howey s first prong. SEC v. Shavers, No. 4:13-11

18 CV-416, 2014 WL , at *1. Token holders here used a digital form of cash through fiat or digital currency to purchase their Chards, and therefore the first prong of the Howey test is satisfied. B. The investment is a common enterprise because all investors shared the same risks and benefits of Chard ownership. Prong two of the Howey test asks whether the investment of money was a common enterprise. Howey, 328 U.S. at 301. The majority of circuit courts use the horizontal commonality test to determine whether there is a common enterprise. (R. at 12.) Horizontal commonality requires the pooling of investors funds so that every individual investor shares in all the same risks and benefits of the enterprise; each investor must be similarly situated to all the other investors. SEC v. SG Ltd. 265 F.3d 42, 44 (1st Cir. 2001); Curran v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 622 F2d. 216, 221 (6th Cir. 1980). The appellate court correctly applied the horizontal commonality test to determine a common enterprise did exist. All of the Chardin Network investors are similarly situated because they all pooled their money into the enterprise and received Chard tokens with identical voting abilities attached. The Chards that the Chardin Network retains do not come with these voting rights; investors must purchase or earn the Chards to receive voting power (small though this power may be.) Additionally, all Chard token holders are exposed to the same risks and benefits of the enterprise. For example, the cybersecurity attacks opened all investors to the risk of losing their money and tokens, while the initial 12

19 success of the Chardin Network s ICO provided increased value and benefits to all the investors. Therefore, the purchase of Chard tokens constituted a common enterprise because all investors were similarly situated and open to identical risks and benefits. C. The white paper proves that token holders reasonable expectation of profits superseded their interest in purchasing Chards to use. The third Howey prong requires a reasonable expectation of profits. United Hous. Found., Inc. v. Forman, 421 U.S. 837, 852 (1975). Profits include the increased value of the investment as well as anticipated capital appreciation and earnings coming from the use of the investor s funds. SEC v. Edwards, 540 U.S. 389, 393 (2004); Forman, 421 U.S. at 852. In these scenarios, the investor is attracted by the potential profit of the investment, not a desire to use the item, though often both motivations exist. See, e.g. Forman, 421 U.S. at 853 (holding that stock in a cooperative housing arrangement was not a security where buyers only bought stock to live there.) But see SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 348 (1943) (holding that leases were securities where the leasehold interests themselves were no more than an incidental consideration and buyers were mainly lured by the potential return from exploratory oil drilling.) To determine whether investors primary interest in the securities was for profit or consumption, the relevant law looks to security issuers representations. See e.g., Forman 421 U.S. at 852 (looking at an Information Bulletin to decide investors main attraction); 13

20 SEC v. SG Ltd., 265 F.3d 42, 54 (1st Cir. 2001) (looking at persistent representations of future profits.) In the instant case, investors primarily bought Chards because of the potential increase in value on secondary markets, and their interest in Chards as a social media token was secondary. The Chardin Network s representation in the white paper emphasized the Chards potential value on secondary markets and enticed investors to see Chards as an opportunity for future return. (R. at 4.) Furthermore, the white paper told token holders that, by voting on contract proposals, their investment potentially allowed them to help the Custodians grow the business and its profits, and revolutioniz[e] the future of commerce. (R. at 4 5.) Though it is true that the white paper also called Chards a utility token (R. at 3.), the economic realities that should inform all Howey analyses paint a different picture. Two months after the ICO, merely 15% of outstanding Chards (that is, Chards not in possession of the Chardin Network as an entity) had been used on InforMe. (R. at 15.) This includes any Chards owned by an investor who was primarily attracted to Chards as a profit opportunity, but also decided to use some of them. At the time of the ICO, Chards were only compatible with InforMe, a social media platform used almost solely in France. (R. at 1, 6). It is unclear from the record whether the ICO was open only to French citizens, but it is likely that non-french citizens without profiles on InforMe purchased Chards during the ICO, and the record does show that 40% of ICO buyers were 14

21 not registered on InforMe. (R. at 6.) If individuals who do not even have access to InforMe were purchasing tokens, then it must have been in anticipation of their future capital appreciation, and not as a utility token, since they could not have used it anywhere except InforMe. Recent rulings from the SEC provide further confirmation that cryptocurrencies can and have satisfied the four-prong test. The SEC found that digital tokens called MUNs sold to investors in an ICO to raise capital for a blockchain based app was a security because the Munchee company emphasized the expected increase in value and opportunity for profit and promised in its white paper that a secondary market would exist for MUNs. MUNCHEE INC., 3 S.E.C , Securities Act Release No (Dec. 11, 2017). Like Chards, MUNs were both utility tokens and investment vehicles, but the SEC said that investors would reasonably believe they could profit by holding or trading MUN tokens, whether or not they ever used the Munchee App or otherwise participated in the MUN ecosystem, based on Munchee s statements in its MUN White Paper and other materials." MUNCHEE, INC., 3 S.E.C. at 5. Therefore, they were investment contracts and securities subject to United States securities laws. Because the white papers bolstered buyers expectations of profits, the vast majority of token holders did not use their tokens on InforMe, and some investors are not even active on InforMe, investors reasonable expectation of profits outweighed their interest in Chards as a 15

22 consumption commodity. Additionally, the SEC found that MUNs, which were marketed very similarly to Chards and were both utility and investment tokens, satisfied the Howey test because Munchee created a reasonable expectation of future profits despite the fact that MUNs could be used in an app. Thus, Chards satisfy the third Howey prong. D. Profits came from the efforts of others because token holders did not have sufficient control over the Chardin Network. The final Howey prong asks whether the expectation of profits was derived from the entrepreneurial or managerial efforts of others. Forman, 421 U.S. at 852. The managerial efforts of others must be the undeniably significant ones... which affect the failure or success of the enterprise. SEC v. Glenn Turner Enters., Inc., 474 F.2d 476, 482 (9th Cir. 1973). This implies investors may have some duties, but if they are nominal or insignificant, they lack real control over the enterprise, signaling the existence of an investment contract. Williamson v. Tucker, 645 F.2d 404, (1981) (citing Fargo Partners v. Dain Corp., 540 F.2d 912, (8th Cir. 1976)). Where the investor s duties are insignificant, they may also lack access to crucial information about the company, and require the greatest protections of the securities laws. Id. at 422 (citing Hirsch v. DuPont, 396 F. Supp 1214, 1222 (S.D.N.Y. 1975)). Finally, the reasonable expectation of profits cannot come from market fluctuations alone; the security issuer s managerial efforts must be what affects the investment s success or failure. See SEC v. Belmont Reid & Co., 794 F.2d 1388, 1391 (9th Cir. 1986) (holding that the sale of gold 16

23 coins was not an investment contract because the expected profits came from market fluctuations.) Although Chards gave voting rights to token holders, these rights do not provide significant control over the Chardin Network because they were perfunctory rights. Token holders could only vote on Small Bid contracts after Custodians already reviewed them and determine[d] if a particular proposal will be put up to a token holder vote. (R. at 4.) (Emphasis added). Custodians are the first line of review for all Small Bid contracts and, out of the eight proposals submitted after the ICO, token holders only ever got to vote on one. (R. at 6.) Token holders are shut out of any discussion about contract terms as well; their only managerial power is a choice between yes or no after Custodians decide with whom the business will contract and on what terms. These clearly are the undeniably significant decisions, not the investors choice between a thumbs-up and thumbs-down. While it is true that Large Bid contracts go straight to a token holder vote, the economic reality that Howey demands shows that no Large Bids were submitted, so token holders could never exercise that trivial control. (R. at 6.) It is strongly implied in the record that token holders have no say over the contract terms of Large Bids either. (R. at 5.) Even though the contract terms were posted, it is likely that they were too long and technical for even a somewhat sophisticated investor to understand, so many token holders were likely 17

24 voting without clear information or a complete understanding of what they were approving. The Chardin Network hoped to attract tech-savvy investors, but had no requirements about who could purchase Chards and who could serve as Custodians, except for barring the early investors, who ironically are most likely to be knowledgeable about and interested in blockchain technology. (R. at 3.) Although the white paper contains many empty promises about allowing investors to control the company, the Chardin Network surely did not intend for the average purchaser to have control over multi-million dollar decisions. That is the Custodians responsibility. As made clear in the white paper: [H]andling day-to-day operations, maintaining the Chardin source code, and handling ordinary business transactions... review[ing] [Small Bid] contract proposals... modifying the Chardin source code to function on the new [social media platforms, and]... investigating any breaches in the Chardin network are all duties the Chardin Network felt could not be trusted to ordinary investors and are instead kept in-house without the input of token holders. (R. at 3 5.) If investors are uninformed about the investment scheme, it is a strong indicator that they do not have significant managerial control or duties. SEC v. W.J. Howey Co., 328 U.S. 293 (1946); see also Fargo, 540 F.2d at 915. Though token holders had limited power to vote on who the Custodians were, it is clear that the managerial control was meant to stay with the Custodians, not the investors. 18

25 The expected profits of the Chardin Network are not attributable to ordinary market fluctuations. This is apparent in the record. The white paper states that the company will grow by incorporating new social media apps and accepting bids, a task left almost solely to the Custodians as explained above. Lagadere himself says the initial success of the Chardin Network is due to the strength of the security group, not because the market generally was doing especially well. (R. at 7.) When the Chards value fell, it was not in conjunction with a drop in price across the cryptocurrency market, but because of the fraudulent actions of Bouvier, a Custodian. (R. at 6, 8.) Finally, any comparison to silver bars, gold coins, sugar markets, or other markets for fungible goods is not on point. See Noa v. Key Futures, Inc., 638 F.2d 77 (9th Cir. 1980); Belmont Reid, 794 F.2d at 1388; Sinva, Inc. v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 253 F. Supp. 359 (S.D.N.Y. 1966). Unlike Chards, these commodities are not managed by a central board of directors or Custodians. The Custodians and the Chardin Network are the main promoters of Chardin source code adoption and thereby Chard tokens. Even other cryptocurrencies like Bitcoin are decentralized and not managed by a corporate entity; they are wholly vulnerable to market fluctuations. But the white paper s description of the Custodian s entrepreneurial and managerial efforts demonstrates that investors reasonably expected their profits to come from the Custodian s business decisions and acumen, not just market fluctuations. It was the efforts of 19

26 the Custodians and those within the Chardin Network that were essential to the success and failure of the enterprise. The SEC recently ruled that DAO tokens, a token substantially similar to Chards, are securities. REPORT OF INVESTIGATION PURSUANT TO SECTION 21(A) OF THE SECURITIES EXCHANGE ACT OF 1934: THE DAO, Exchange Act Release No (July 25, 2017). Like the Chardin Network s white papers, the DAO website s white papers described their vision for the growth of the company and how token holders voting rights were mostly restricted to proposals already vetted by the DAO s curators. Id. The DAO s curators and the Chardin Network s Custodians predetermined company protocols and retained control over the minutia of how the businesses should be run, including monitoring operations, safeguarding the network, and determining what contract proposals should go to vote. Id. Since the SEC, the agency charged with regulating securities, found these facts to demonstrate sufficient managerial control for DAO tokens, the same should apply to Chard tokens. Token holders did not have substantial control of the Chardin Network and were dependent on the managerial efforts of the Custodians. The token holders perfunctory voting rights and lack of technology expertise signal that the Custodians intended to control the major decisions of the enterprise. The SEC found DAO tokens to be securities under substantially similar circumstances. The final Howey 20

27 prong is satisfied, and with all four prongs met, Chard tokens meet the statutory definition of a security. II. THE TRANSACTION SATISFIES THE DOMESTICITY REQUIREMENT OF SECTION 10(B) OF THE EXCHANGE ACT The Circuit Court correctly held that the sale of Chard tokens to Petitioner constituted a domestic transaction under the two-pronged test established in Morrison v. Nat'l Australia Bank Ltd., 561 U.S. 247, 247 (2010). As articulated in Morrison, Section 10(b) of the exchange act does not provide a cause of action to foreign plaintiffs suing foreign and American defendants for misconduct in connection with securities traded on foreign exchanges. Id. The focus is not where the deception took place, but on purchases and sales of securities in the United States. Id. at 249. Section 10(b) applies only to transactions in securities listed on domestic exchanges and domestic transactions in other securities. Id. This test provides two prongs with each to evaluate the transaction at hand. For a securities transaction to create liability under Section 10(b), it must have involved either (1) securities listed on domestic exchanges or (2) domestic transactions in other securities. A. The transaction satisfies the first prong of the Morrison test. The Circuit Court erred in concluding that the transaction does not satisfy the first prong of Morrison. The focus of the Morrison court was limited to the sale of securities on a foreign exchange. As a result, its holding did not specifically address whether a domestic OTC market would satisfy the first prong s definition of a domestic exchange. The 21

28 court s focus was on distinguishing domestic and foreign exchanges, evidenced by the opinion having quoted the purpose of the Act to illustrate its desire to draw a bright line between foreign and domestic exchanges, not between domestic exchanges and the domestic OTC market. SEC v. Ficeto, 839 F. Supp. 2d 1101, 1109 (C.D. Cal. 2011). The statutory language and legislative history of Section 10(b) of the Exchange Act support applying liability to securities transactions on the domestic OTC market. Id. The Exchange Act's explicit purpose is [t]o provide for the regulation of securities exchanges and of over-the-counter markets operating in interstate and foreign commerce and through the mails, to prevent inequitable and unfair practices on such exchanges and markets, and for other purposes. Id. at The Act's Senate Report also articulated the vital importance of authorizing the SEC to subject [OTC markets] to regulation similar to that prescribed for transactions on organized exchanges. S. REP. NO , at 6 (1934). It was argued that such authority was needed to forestall widespread evasion of stock exchange regulation by the withdrawal of securities from listing on exchanges, and by transferring trading therein to over-thecounter markets where manipulative evils could continue to flourish, unchecked by any regulatory authority. Id. The language of the statute makes clear the intent to treat securities on OTC markets similarly to those traded on national exchanges. Ficeto, 839 F. Supp. 2d at

29 The Exchange Act definitions further support the inclusion of OTC markets under the first prong of the Morrison test. Section 78c of the Exchange Act does not provide a definition for national securities exchanges, but does provide a general definition of an exchange: [A]ny organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange. 15 U.S.C. 78c(a)(1) (2012). The court should refer to the clear definition provided by the statute as it supports the conclusion that Pyrenees s activities as a cryptocurrency brokerage firm satisfy the statutory definition of exchange. The firm is an organization that provides a marketplace for bringing together purchasers and sellers of securities. For the aforementioned reasons, this transaction satisfies the first prong of Morrison, establishing liability for the sale of any security listed on a domestic exchange. B. The transaction also satisfies the second prong of the Morrison test. The transaction also satisfies the second prong of the Morrison test. The second prong holds that Section 10(b) liability applies to all domestic transactions in securities not registered on domestic exchanges. Morrison, 561 U.S. at 268. Foss is a United States citizen, Pyrenees is a United States corporation, and this sale took place within 23

30 the United States. (R. at 22.) This transaction clearly satisfies the second prong of Morrison. The Second Circuit refined the domestic requirement of Morrison s second prong in Absolute Activist. Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 68 (2d Cir. 2012) (holding that a securities transaction should be understood as having occurred in the location where title is transferred). In order to sufficiently allege a domestic securities transaction in securities not listed on a domestic exchange, [the court held] that a plaintiff must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States. Id. This transaction also satisfies the irrevocable liability requirement of Absolute Activist. Foss s purchase of Chard tokens from Pyrenees took place in an OTC transaction within the United States. (R. at 8.) The second prong of Morrison was again addressed by the court in Parkcentral, which held that claims that were so predominantly foreign as to be impermissibly extraterritorial were beyond the scope of Section 10(b). Parkcentral Glob. Hub Ltd. v. Porsche Auto. Holdings SE, 763 F.3d 198, 216 (2d Cir. 2014). Parkcentral involved the purchase of swap agreements that were tied to the value of a security that was exclusively sold on a foreign exchange. Id. at 213. Given the predominantly foreign nature of the exchange, the court found that the purchase of the swap 24

31 within the United States was not enough to satisfy the second prong of Morrison. Id. at 216. [T]he imposition of liability under 10(b) on these foreign defendants with no alleged involvement in plaintiffs' transactions, on the basis of the defendants' largely foreign conduct, for losses incurred by the plaintiffs in securities-based swap agreements based on the price movements of foreign securities would constitute an impermissibly extraterritorial extension of the statute. Id. at The facts of Parkcentral are noticeably distinct from this transaction. The sale of the Chard tokens took place within the United States, the same locale in which the relationship between Pyrenees and the Chardin Network originated, and in which the tokens were marketed by the issuer itself. In spite of the identities of the issuer s French citizenship and incorporation, the transaction cannot be described as predominantly foreign. (R. at 1.) C. Petitioner s behavior is akin to that of an issuer of a sponsored ADR. Petitioner, having conceded that the transaction was domestic, argues nonetheless that the issuer was not sufficiently involved in the transaction to be held liable under Section 10(b). This court should reject any analogy to sales involving sponsored and unsponsored ADRs. Stoyas v. Toshiba Corp., 191 F. Supp. 3d 1080, (C.D. Cal. 2016). Unsponsored ADRs are established with little or no involvement of the issuer of the underlying security, while sponsored ADRs are established with a degree of active participation of the issuer. Id. The distinction is often emphasized in order to suggest that no liability should result to 25

32 issuers of unsponsored ADRs due to a lack of involvement with the transactions in the United States. A distinction between the two is that issuers of sponsored ADRs generally enter into an agreement with the depositary bank as well as the ADR owners, which outlines the terms of the ADRs and the rights and obligations of the parties, such as the ADR holders' voting rights. Id. Ultimately, whether a security might be characterized as sponsored or unsponsored should not control as it relates to Morrison, given the minimal difference between a sponsored and unsponsored ADRs. SEC Rule 12g3-2, codified at 17 C.F.R g3-2 (2008), allows for foreign unsponsored ADR sales only under the express condition that the issuer maintains its listing on a foreign exchange and complies with the requirements to provide American investors with electronic access to English-language translations of the information provided to their foreign-investors. Stoyas, 191 F. Supp. 3d at This requirement highlights the fact that even an unsponsored ADR issuer remains responsible for the disclosure of material information to potential purchasers of their securities within the United States. The only difference between a sponsored and unsponsored ADR is that an unsponsored ADR does not require a formal application by the foreign issuer to establish an ADR program. Id. As articulated by the plaintiffs in Toshiba, the importance of holding foreign issuers of unsponsored ADR sales liable in the United States is that doing so prevents them from 26

33 evad[ing] liability by refusing to memorialize [their] consent to the sale of ADRs. Id. Even if the court were to find the distinction between sponsored and unsponsored ADRs to be material, the case at hand shows that it would be unjust to allow security issuers who do not memorialize their consent to the sale of the security in the United States to evade liability. Unlike Toshiba, which concerned the purchase of foreign securities on a foreign exchange with little involvement from the issuer, Bouvier and his colleagues at the Chardin Network were highly involved in this transaction. (R. at 7.) Bouvier s close colleague, Marcel Lagadere, initiated a discussion regarding the possibility of using Pyrenees as an intermediary to facilitate the sale of Chard tokens within the United States. (R. at 7.) Lagadere explained to Pyrenees that the Chardin network was concerned and confused about the regulatory environment in the United States. (R. at 7.) When the Chardin Network decided to sell Chard tokens to Pyrenees, with the purpose of those tokens ultimately being sold to individuals in the United States, Bouvier asserted that neither he nor the Chardin Network should be involved in the scheme. (R. at 7.) In spite of this awareness that such a business decision might expose the Chardin Network to regulatory liability, the transaction went forward without any communication between the Chardin Network and the SEC. (R. at 7.) Bouvier s stated desire to remain uninvolved in the transaction was unfulfilled as the Chardin Network chose to list its white 27