Will 2020 be the year that censured ICOs sue their advising law firms? If the action against Faegre Baker Daniels is any indication, the answer is “yes.” But do these cases have merit?
ICO Suing Advising Law FirmDigital Capital Management, which developed a cryptocurrency investing fund called Crypto Asset Management, is suing international law firm Faegre Baker Daniels for allegedly administering “questionable advice.” According to the complaint, Faegre Baker Daniels supposedly steered the fund away from registering with the Securities and Exchange Commission — as stipulated under the Investment Adviser Act of 1940 — because its structure didn’t constitute a security. The SEC disagreed, and in 2018 slapped the fund with an enforcement action and $200,000 fine for failing to register despite qualifying as an “investment company.” Now, the finance firm is pointing a finger at its law firm for counseling that cryptocurrency assets weren’t securities.
Are Cryptocurrencies Securities?The suit’s gravamen is whether or not Digital Capital Management’s product qualifies as a security. Unfortunately, the answer isn’t crystal clear. Some crypto ventures do fall under the securities umbrella; others don’t. Judges use “the Howey Test” to make the determination.
What is the Howey Test?Developed for a Supreme Court case (SEC v. W.J. Howey Co.) involving a 1940s orange grove opportunity, the Howey test examines four elements of a financial product to determine whether or not its a security. The Howey Test defines an investment contract as one where a party:
- Invests money,
- In a common enterprise,
- With the expectation of profiting,
- Based on the efforts of a third party.