To show the markets that the Securities and Exchange Commission is not just about slapping around wrong-doers, but also trying to help people navigate the securities laws, the SEC’s FinHub published a framework for analyzing whether a digital asset is a security.
The framework is not intended to be an exhaustive overview of the law; rather, it is a tool to help market participants assess whether the federal securities laws apply to the offer, sale, or resale of a particular digital asset.
Did anyone find it strange that the “framework” document had not statement of the author or publisher? There is not even an SEC symbol.
That should be a warning that you can’t rely on it. It’s not official guidance. It’s not a no-action letter.
It is a comprehensive look at the Howey test in the lens of cryptocurrency. The Supreme Court’s decision in SEC v. W.J. Howey Co. found that an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. If it’s an “investment contract,” it’s a security and subject to securities laws.
The framework quickly jumps over the first two prongs of the Howey test:
the “investment of money” and “a common enterprise.” That’s true in most of the “What is a Security?” cases.
The framework focuses on the “expectation of profits from the effort of others” prong of the Howey test. The Framework splits that into two parts.
Generally, if you make an investment you expect to make a profit. Otherwise it’s just a purchase for use. I bought a cup of coffee this morning. I had not expectation of profit. I had an expectation of getting coffee. I bought it with a stored value card from Starbucks. It’s not an investment. Those could have been Starbucks coins.
You can see an obvious problem with ICOs that talk about how much the coins are going to increase in value. That injects an expectation of profit. The framework lays out a long list of characteristics that make sit likely the SEC will see that there is an expectation of profits.
“Lambo, Lambo, Lambo” was not specifically on the list. They took a more demure “able to earn a return on their purchase.”
The framework inquiry into whether a digital coin purchaser is relying on the “efforts of others” focuses on two key issues:
- Does the purchaser reasonably expect to rely on the efforts of an active participant in running the underlying platform?
- Are those efforts “the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise,” as opposed to efforts that are more ministerial in nature?
If there is a key person responsible for the development of the platform and making the decisions, that makes it look an investment.
To put this framework into play the SEC also announced a no-action letter for the Turnkey Jet token sale (TKJ) and found that it would not recommend enforcement because it was not a securities offering.
In reaching this position, we particularly note that:
1. TKJ will not use any funds from Token sales to develop the TKJ Platform, Network, or App, and each of these will be fully developed and operational at the time any Tokens are sold;
2. the Tokens will be immediately usable for their intended functionality (purchasing air charter services) at the time they are sold;
3. TKJ will restrict transfers of Tokens to TKJ Wallets only, and not to wallets external to the Platform;
4. TKJ will sell Tokens at a price of one USD per Token throughout the life of the Program, and each Token will represent a TKJ obligation to supply air charter services at a value of one USD per Token;
5. If TKJ offers to repurchase Tokens, it will only do so at a discount to the face value of the Tokens (one USD per Token) that the holder seeks to resell to TKJ, unless a court within the United States orders TKJ to liquidate the Tokens; and
6. The Token is marketed in a manner that emphasizes the functionality of the Token, and not the potential for the increase in the market value of the Token.
The Turnkey Jet token is a stored value card saved on the blockchain instead of a central account. That’s closer to buying a cup coffee than it is to investing.
Of course, the framework is just the SEC’s view on securities law question under federal law. There are also state law analyses that need to be done.
Sources:
- Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets”
- Framework for “Investment Contract” Analysis of Digital Assets
- Turnkey Jet No-Action Letter
- SEC staff advises on ‘investment contract’ analysis for digital assets, grants relief to company selling tokens for services by Amy Leisinger, J.D.
- Will The SEC’s Framework Beget Blue Sky Blues For Digital Assets? by Keith Paul Bishop