Earlier today, William Hinman, the Director of Corporation Finance at the SEC, made remarks at the Yahoo Finance All Markets Summit: Crypto that have crypto entrepreneurs and investors breathing a sigh of relief – namely, that ether, the second-largest cryptocurrency by market cap behind bitcoin, is not a security.
This wasn’t news to securities lawyers, because ether no longer passes the Howey test, as I pointed out earlier in the week. I didn’t get into the reasoning for my position, but if you’re interested, Peter Van Valkenburgh lays out the argument very well.
What I want to bring to your attention here is the helpful guidance Hinman provided in his remarks (I really do think they’re helpful, despite the title, which I couldn’t resist). The guidance is very welcome because, although the SEC has been very clear and consistent in its position that cryptocurrencies issued in ICOs are securities, the agency has not provided much else in the way of guidance. Chairman Clayton occasionally made what I considered reassuring remarks, wherein he consistently reiterated that a significant factor is whether “the thing” (ie, the network on which the tokens will operate) has been built, or not. In the former case, they’d be securities; in the latter case, perhaps not. But beyond that, we’ve not had much to rely on except seventy years of case law, which is only of marginal help if you don’t know what the agency’s current thinking is, especially since all of those cases predate the blockchain.
Now, thanks to Hinman’s comments, we have more to chew on. Granted, there’s no relief in his words for those wishing to conduct an ICO in the US and avoid the securities laws. But for those companies whose business model provides for the sale or issuance of tokens other than in connection with a financing – very much a grey area – his comments provide useful guidance.
In fact, I think now we’ll begin to see the SEC issue ‘no-action letters’, which are responses to requests made of the SEC by companies that want to engage in certain activity, but prior to doing so, want assurance from the SEC that the agency won’t recommend enforcement action. The no-action letters give comfort not only to the party making the request, but also provide helpful guidance on which other market participants can rely. In other words, it’s another way for the SEC to define the regulations. As a side note, if you intend to issue tokens and don’t believe they qualify as securities, get in touch – perhaps we can help you make a no-action request of the SEC.
Back to Hinman’s factors. As you read through these, keep in mind that this is not an exhaustive list. The determination of whether a token is, or is not, a security depends on the facts and circumstances of each particular case.
From his remarks:
“What are some of the factors to consider in assessing whether a digital asset is offered as an investment contract and is thus a security? Primarily, consider whether a third party – be it a person, entity or coordinated group of actors – drives the expectation of a return.
He goes on to provide additional “contractual or technical” considerations that can be used to determine whether the digital assets function more like a consumer item and less like a security. They are: