Instagram Promoters Test Limits of 90-Year-Old Securities Law

A Depression-era securities law is forcing courts to wrestle with what it means to sell securities in the age of YouTube and Instagram as venture capital firms and others hyping investment projects online are facing lawsuits from disgruntled buyers.

Federal law has for decades allowed investors who are defrauded or who bought an unregistered security to sue the seller, seeking a refund. New kinds of investments, including crypto projects promoted on social media, have tested the definition of “seller.”

The US Supreme Court this month declined to hear a case involving real estate management company Cardone Capital LLC. Cardone argued two major appeals courts have split with other circuits by finding social media use can make someone a seller.

Lower courts, meanwhile, are increasingly being asked to consider whether making online videos or otherwise touting crypto tokens is a solicitation that makes someone a seller.

Decisions finding that YouTube videos and social media posts were solicitations could be interpreted as trying “to put some discipline on emerging investment vehicles,” said Danielle Myers, a Robbins Geller Rudman & Dowd LLP partner who represents shareholders in securities litigation.

But courts’ emerging interpretations of solicitation have created uncertainty for companies promoting investment projects about what they can do online without exposing themselves to a lawsuit.

“It’s not defined where that line is—how much is enough?” said Ann Lipton, a business law professor at Tulane University focused on corporate governance and investors.

Mass Communication

The definition of seller includes someone who solicits a sale, motivated by either their or the security owner’s financial interests. The 1933 Securities Act, enacted after the massive stock market crash of 1929, allows investors to sue sellers to rescind the purchase of securities that aren’t registered with the Securities and Exchange Commission, as well as those sold through a false or misleading prospectus.

Following a 1988 Supreme Court decision, Pinter v. Dahl, many lower courts required the defendant in such cases to have had direct contact with the plaintiff to be considered a seller. For example, a coal company that prepared and circulated the prospectus to individual plaintiffs was found to be a seller — but clothing company executives who participated in road shows weren’t, when they had no direct contact with the suing investor.

A district court applying that standard found Cardone’s CEO, Grant Cardone, wasn’t a seller after an investor sued in 2020. While Cardone in YouTube and Instagram videos promised a 15% return from real estate investment funds, the court said he wasn’t “directly and actively involved in soliciting Plaintiff’s investment.”

The Ninth Circuit in December reversed the decision and said promoting the sale of securities in “mass communication,” including social media, can make someone a seller.

That followed a similar ruling last year from the Eleventh Circuit, allowing a suit to proceed against the online promoters of BitConnect, a crypto lending platform authorities say was a Ponzi scheme. The appeals panel in Wildes v. BitConnect focused on whether the defendant “urged” another person to buy a security.

“If you’re making a public statement urging or persuading someone to invest in security XYZ, then you’ve solicited” under those decisions, Jeffrey Steinfeld, a securities litigation partner at Winston & Strawn LLP, said. The statement doesn’t need to be “personalized,” Steinfeld said.

Notably, the Ninth Circuit pointed out the Securities Act’s definition of “prospectus” includes “communication, written or by radio or television.” The court said it was clear Congress considered “broadly disseminated, mass communications” would fall within the scope of the law.

“The Eleventh Circuit and Ninth Circuit cases are the first two to deal with the 2020 version of radio or television—what does mass communication mean in 2020 or 2023,” said Robins Geller’s Myers.

The lawsuit against Cardone was dismissed on other grounds days after the Supreme Court refused the case.

Crypto Trap

The appellate rulings have touched Silicon Valley, where the Ninth Circuit’s broad interpretation of a securities seller ensnared private equity and investment firms in a recent high-profile crypto case.

Firms including Bain Capital and Andreessen Horowitz are defendants in a lawsuit brought by buyers of crypto tokens that were created by Compound Labs. Buyers allege the firms are part of a small group that controls the Compound business, and that the tokens are unregistered securities.

The complaint said Andreessen and other defendants promoted the tokens in public statements. Andreessen, for example, called them an “instrument for effectively distributing the fundamental value of” the Compound business, according to the complaint.

The defendants also paid Coinbase—one of the largest crypto exchanges—to show videos on its website promoting Compound, the plaintiffs said in court filings. That was “even more obviously a solicitation than” the YouTube videos in the Cardone v. Pino case that the Supreme Court declined to hear, the plaintiffs argued.

A judge in the US District Court for the Northern District of California refused to dismiss the lawsuit, rejecting comparisons the defendants drew to a recently dismissed New York case brought by crypto buyers looking to hold Uniswap liable for alleged scams on its decentralized trading platform.

The Uniswap case was decided under a “materially different standard,” Judge William Orrick said.

The standard for solicitation “is decidedly broader in the Ninth Circuit, as confirmed by Pino, where ‘direct’ contact is not required and liability may flow from mass communications,” Orrick wrote in a September ruling.

Bain and other defendants have asked Orrick to reconsider. Andreessen said the decision “would expand solicitation liability far beyond Pino’s facts and holding.” Another investment firm, Polychain Alchemy LLC, argued much of what it said publicly concerned general business information about Compound’s tokens.

If that’s enough to be a seller, Polychain said in court documents, “it would turn any investor who describes its investment into a ‘solicitor’ under the Securities Act.”

What’s Enough?

The Ninth Circuit and Eleventh Circuit have split from other circuit courts, Cardone told the Supreme Court, a view echoed by some securities lawyers.

But others said it’s not clear the cases would be decided differently in other courts.

The direct-contact standard was developed largely in the context of traditional securities offerings, like initial public offerings. Earlier district court cases were “preparing for a different world,” said Lipton, the Tulane law professor.

The uncertainty has created a murky situation for investment companies and promoters, lacking bright-line rules about the kinds of online activities that would push them into the territory of being a seller who can be hauled into court.

In New York, a federal judge earlier this year found Coinbase wasn’t a seller when it participated in “airdrops” of new token offerings, wrote updates about price movements of the tokens, and linked to related stories. The court, in a decision being appealed to the Second Circuit, said that wasn’t enough to establish solicitation.

“It’s not obvious what is enough, because no court has really articulated it, other than some degree of either requiring direct contact in some cases—or ‘I know it when I see it’ in others,” Lipton said.