Is (CAPP) a security?
Recently, (CAPP) released a report from a law firm, that ran a legal analysis of their token to see if, in the opinion of the law firm, (CAPP) would be seen as a security or not in the courts. Personally, I think the analysis is very well done, there are many positive arguments made therein that can be applied on the basis that (CAPP) is not a security. The analysis was conducted by Albrecht & Vitte Ltd.
However, a few cases are made that explain varying degrees in which the token could be seen as a security. In finality, (CAPP) does not seem to fit the definition of a security. Although it may meet a few of the criteria, it does meet enough of the legal prongs to be applicable in this case it seems. I’ll break down the things that stuck out the most to me in this paper that, in my opinion, make a well-rounded argument explaining why (CAPP) is not a security.
It’s mentioned in the analysis that future changes in the law within this area as it develops could change. For the analysis, the law firm researched the Whitepaper of Cappasity, watched numerous video presentations, reviews on the website and youtube, scrutinized the marketing content available on the ICO channels available on the web, and consulted with the founders.
(Very thorough and that’s good to see)
When being scrutinized on whether or not something is a security there are four main prongs that need to be met;
1. An investment of money
2. In a common enterprise
3. With an expectation of profits
4. Solely from the efforts of others. (E.g., a promoter or third party)
Is (CAPP) an investment of money?
The first prong that is considered is whether or not CAPP requires an investment of money. On August 6th, 2013 a court in Texas held that Bitcoin was within the definition of “money”. It was stated that Bitcoin may be used to purchase goods or services to pay for individual living expenses. The limitation is that it can only be used where it is accepted. Because Bitcoin or any other cryptocurrency has features inherent to all currency functions it can be considered “money”. Therefore, the first element of the test is quite clear, and in this specific regard, CAPP can be pushed on the scale towards being an investment instrument.
Are the (CAPP) founders a “common enterprise?”
The second prong is not met by (CAPP). The Supreme Court fails to specify the definition of a common enterprise the Federal circuits developed two different concepts to analyze the underlying relationships between the parties. They are known as “horizontal commonality” and “vertical commonality”
In law, horizontal commonality is defined as;
A) Investors contributions are pooled together.
B) The fortune of each investor rests on the success of the overall enterprise.
In the case of vertical commonality, the investors’ fortune is dependent on the expertise of the promoter or third parties. Furthermore, narrow vertical commonality is defined when investors profits are tied to the profits of the promoters. Therefore, it’s not necessary that the funds are pooled. What must be proven is that the fortunes of investors are linked with those of the promoters thereby establishing a requisite element of vertical commonality. Thus, a common enterprise exists if a direct correlation can be drawn between the success or failure of the promoters efforts and the success or failure of investments.
According to the above-mentioned rules, the horizontal common enterprise is distinguished by investors pool their contributions. In that regard, the prong is met. On the other hand, it cannot be inferred that the fortune of each investor rests on the success of the overall enterprise. One could argue that indeed the success of the platform launch would also mean that each CAPP holder shall equal the success of another. In the same regard, the failure to launch the platform would also affect all token holders. However, the firm states this argument has many flaws because;
“Cappasity has been working with Intel since 2014, and developed a 3D scanning software”
There, in that sense, neither developers nor enterprises or users are very dependent on the successful platform deployment and functionality. Secondly, Cappasity is a separate entity that bears its own risks and as a result, enjoys the potential profits as well. Finally, the project’s ecosystem is not designed to share any profits between the project users.
In the case of the vertical enterprise test, it is not necessary for the funds of investors are pooled; what must be shown is the fortune of the investors being linked directly to those of the promoters. That connection would establish a requisite of vertical commonality meaning an enterprise would exist if the direct correlation has been established between the success and the failure of the promoters efforts and the investors’ funds as well.
This is not the case because the risks a CAPP holder accepts are of an absolutely different nature than the risks that the promoters incur. The promoters risks primarily fall within the development of software or finding enterprises, developers, and creators to boost the economy within the project. Whereas, the investors are at risk only if the declarations in the whitepaper are not realized.
“We believe that content creators will drive 3D revolution. That is why we are introducing the first platform that solves the problem of creating and embedding 3D, and AR/VR content in an affordable way. The cappasity platform uses blockchain infrastructure to store and manage 3D digital asset copyrights”
In broad vertical commonality, the success of investors depends on the efficacy of managers/third parties. But once the project has been launched, and the platform works properly, every member of the project starts to pursue its own purposes and in that pursuit, they will face their own individual risks. Any potential misfortunes or failures, at that point, would not be commingled with the fortunes of the Project enterprise. Therefore, in the opinion of the law firm. CAPP token does not satisfy a common enterprise element of the Howey test.
Does (CAPP) have an expectation of profit?
When considering the “expectation of profit” element, that element is also not met for the reasons below.
The case law analyzed by the firm revealed that the definition of “profits” can be construed in quite a broad manner and may include not only fiat currency but also other benefits. However, even if the above mentioned is true, it becomes a superficial analysis of the project at stake.
The case here is that there is an expectation of profit from purchases made on any subject of value almost always takes place. The mere expectation of profit is trivial and is not enough substance to satisfy this prong. One must be primarily motivated and has to place speculative interest. For example, to resale any commodity or the right rather than the interest in personally consuming the subject of value. In Re Forman Case, the case law differentiates the distinction between the two as
“It is an investment where one part with his money in hope of receiving the profits from the efforts of others, and not where he purchases a commodity for personal consumption or living quarters for personal use.”
By applying the above-mentioned case law to the case of CAPP, one can infer that inevitably as in any other ICO project CAPP holders can be divided into two groups — those are seeking to use the Product, and those who merely intend to trade it on secondary markets. Also, to be fair, it is admitted that some people who consist of the first group may enter the market to sell tokens due to its appreciation in market price over time.
Nevertheless, this profit cannot be deemed as profit that is generated from the “efforts of others” As stated in the facts described below, CAPP token is designed in such a way to provide its holder with real licensing rights.
“Software tools & SDK Cappasity platform software tools, SDK for AR/VR/3D content generation, embedding as well as data import from popular third-party utilities (Autodesk, Rhino, 3ds, MAX, etc) will be available to the developer community”
“Developers will be free to build their own apps on top of it, embed 3D objects and models and integrate their own products with the available tools”
For those reasons, it is more likely that CAPP holders’ interest in using CAPP is for the most part centered around user consumption. Moreover, in another scenario, an investment contract would be met every time in our own lives when we acquire any commodity or right since many subjects may be appreciated in the future and sold for profit on secondary markets. There are several case laws that support this conclusion as well. In Re Sinva the court asserted that
“The mere presence of a speculative motive on the part of the purchaser or seller does not evidence the existence of an “investment contract” within the meaning of the securities act. In a sense, anyone who buys or sells the horse or an automobile hopes to realize a “profitable investment”. But the expected return is not contingent upon continuing efforts of another” — Sinva v Merril Lynch, 253 F. Supp/ 359, 367 (S.D.N.Y. 1966)
The law firm also investigated the marketing campaign run by the Founders, and they stated it did not reveal any material that would entice people to use CAPP for speculation purposes on the exchange market and in any other way except for personal use. For all of the reasons above. It is more likely to push the scale towards CAPP not being deemed as a security. However, for the secondary market player, it may be deemed fulfilled.
Are profits expected solely on the effort of (CAPP) and others?
When courts analyze this prong they consider whether the investors;
A) Expect to receive profits from their efforts such as the use of rights or services obtained from promoters.
B) From the efforts of the managers or promoters.
Not all courts share the same approach as the Supreme Court when using the term “solely” to define the effort of others.
If the concept of “only” from the effort of others is applied this prong is more likely not to be satisfied. In the opinion of the law firm, CAPP holders use the token as a means of payment, so the more transactions they conduct, the more attractive the Platforms ecosystem is.
However, some Federal courts later relaxed the approach exploiting “de minimis” efforts of others or the concept of “undeniably significant” after In Re Forman case. Therefore, even if the investor has the power to be involved, the transaction may still be an investment contract if the efforts of other predominate.
“Whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise” (The Forman case; SEC v Glenn W. Turner Enters., 474 F.2 d 476 sec.28 (Feb 1, 1973)
The founders work on the software to make it more functional and interesting and as a result, it is more attractive to users. Because the market value may increase in the future, it would be fair to declare that the expected profit is derived from the efforts of others as well. However, there is an inclination to believe that CAPP token holders will rely on the efforts of the Cappasity Founders but only to the extent that the latter will deploy the platform that would permit all parties of the Cappasity Ecosystem to communicate and apply any system features they see fit.
In that regard, CAPP holders are primed by the marketing and engagement of founders. However, as seen from the fact analysis provided before, Founders do not assert in any marketing materials either on the website or within the ICO reviews that the project itself may generate any investment profits for CAPP holders. Although, if the more strict approach of the Supreme Court is applied, this prong is more likely not to be satisfied in the context of the Federal Courts and their views, this element of the Howey Test may be satisfied.
The first prong is satisfied and met and no one shall elude that courts will consider this in any different way. The second prong is much more debatable but within the analysis, there have been multiple elements that are not satisfied under both theories applied by the Federal Courts. The third element is not as satisfactory in the context of personal consumers but it is likely to be fulfilled for the purchasers with the sole intent of selling the tokens on the secondary markets for profits. Finally, the last prong is a toss-up in that, if the approach of the Supreme Court is taken the prong could be satisfied. Whereas, Federal courts it is not. If you’d like to read the full legal analysis you can find it here.
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