framework for investment contracts analysis of digital assets

of Div. The SEC has just released an 11-page statement with an analysis pertaining to digital assets being offered and sold as an investment contract. The Framework provides a helpful discussion of factors a market participant must consider when analyzing whether a digital asset represents an investment contract, especially with respect to … endobj Rather than relying on traditional backers and underwriters with a centralized ledger, ICOs and their associated cryptocurrencies depend on distributed ledger technology, of which blockchain technology forms a subset.9×9. In October 2018, the SEC obtained an emergency court order enjoining Blockvest, a company that allegedly made a series of fraudulent claims regarding its upcoming ICO, from selling any securities.45×45. The bill is specifically aimed at “exclud[ing] digital tokens from the definition of a security” in the Exchange Act and Securities Act.56×56. On April 3, 2019, the SEC released Staff Guidance titled “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which applies the factors set forth in SEC v. W.J. While this framework did not rise to the level of an official statement by the SEC, it generated a lot of excitement in the industry. As to courts providing clarification, through selective enforcement the SEC has essentially precluded judges from interpreting how securities regulations apply to digital assets. For instance, SEC Chairman Jay Clayton expressed concern that, as cryptocurrency and ICO markets are “currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.” Public Statement, Jay Clayton, Chairman, SEC, Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017), https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11 [https://perma.cc/7UT9-4ARZ]. ICOs that are securities offerings, we should regulate them like we regulate securities offerings.”41×41. endobj & Tech. Lael Brainard, Governor, Bd. Proponents of the bill believe that it would “eliminate . A word for word reading and breakdown of the SEC framework for understanding what is a Security Token vs what is a Utility token. See, e.g., Andy Pasztor & Robert Wall, Drone Regulators Struggle to Keep Up with the Rapidly Growing Technology, Wall St. J. See H.R. uncertainty” and provide the clarity “required to spur continued investment and innovation in this technology.”57×57. 18-cv-2287 (S.D. (emphasis added). In most other contexts, electronic transactions are recorded on a centralized ledger, which is managed by a trusted intermediary (for example, a commercial bank) who “track[s] account holders’ balances and, ultimately, vouch[es] for a transaction’s authenticity.” Trevor I. Kiviat, Note, Beyond Bitcoin: Issues in Regulating Blockchain Transactions, 65 Duke L.J. Press Release, SEC, SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities (July 25, 2017), https://www.sec.gov/news/press-release/2017-131 [https://perma.cc/VNU9-Q4CM]. Public Statement, Hinman & Szczepanik, supra note 3. list of over thirty factors to help determine if an investor has a reasonable expectation of profits derived from the efforts of others.33×33. <>>> On April 3, 2019, the SEC attempted to provide clarity by releasing a “Framework for ‘Investment Contract’ Analysis of Digital Assets,”2×2. An initial version of the bill was introduced by Rep. Davidson on December 20, 2018. See H.R. ; see also Complaint at 2–3, SEC v. REcoin Grp. This development is meaningful because it marks a shift away from the former uncertainty, which was likely a function of the SEC’s desire to promote innovation. Oct. 3, 2018), ECF No. 15 U.S.C. 12 0 obj See generally id. The SEC has only acted in the most flagrant fraud cases, which are more likely to settle out of court.58×58. The agency may delay providing clarity by all but ensuring that judges do not get the chance to draw bright-line rules. The fact that the SEC specifically named “decentralized networks” indicates that it is signaling support for decentralized, distributed ledger technology and is trying to meaningfully carve out a space where blockchain-based tokens can function without being labeled securities. (2018). Price appreciation resulting solely from external market forces (such as general inflationary trends or the economy) impacting the supply and demand for an underlying … of Corp. There are also state law analyses that need to be done. The report is titled Framework for “Investment Contract” Analysis of Digital Assets, and is prefaced by the following Public Statement framing it. While the guidance represents an improvement from the incredible ambiguity pervading this burgeoning field, it is an inadequate substitute for clear legislation and judicial rulings. Id. Agencies often struggle to capture emerging technologies in dusty regulatory frameworks14×14. This implies that the use of decentralized networks makes a digital asset somewhat less likely to be an investment contract — and therefore less likely to be classified as a security. <> ICO Fundraising Surges in 2018, Wall St. J. No. SEC, supra note 2. The second piece of guidance came in the form of a “Framework for ‘Investment Contract’ Analysis of Digital Assets” that is intended to … The Court held that a transaction is an investment contract if: (1) there is an investment of money, (2) in a common enterprise, with (3) a reasonable expectation of profits to be derived from the efforts of a third party.19×19. In this report, the SEC described an investigation of the DAO, a virtual organization, and its use of distributed ledger or blockchain technology to facilitate the offer and sale of DAO tokens to raise capital. The investors would then each contract with the current owner of the citrus grove so that the current owner would tend to the trees and harvest the resulting produce. <> stream S Similarly, the staff's response in the TKJ letter focuses on factors that also are identified in the framework. The guidance quickly dispenses with the first and second prongs of the Howey test, stating that the requirements for an “investment of money” in a “common enterprise” are “typically satisfied” in a digital asset transaction.31×31. While the SEC’s framework for analyzing digital assets is promising in that it indicates that not all blockchain-based digital assets will be treated as securities, clear guidance through … The framework was cobbled together by SEC Commissioners Valerie Szczepanik, Senior Advisor for Digital Assets and Innovation aka “crypto czar” and Bill Hinman, director of the SEC’s Division of Corporation Finance. In discussing the analysis for digital assets, for instance, the framework is careful to point out that the inquiry “is an objective one, focused on the transaction itself and the manner in which the digital asset is offered and sold.”61×61. SEC FinHub Publishes Framework for Investment Contract Analysis of Digital Assets 04.08.19 On April 3, 2019, the Strategic Hub for Innovation and Financial Technology (“FinHub”) released a framework for analyzing the application of U.S. federal … Though the new framework is helpful, it is not binding and is not an adequate substitute for clear rules upon which market participants could rely. 2, 2019), https://www.sec.gov/divisions/corpfin/cf-noaction/2019/turnkey-jet-040219-2a1-incoming.pdf [https://perma.cc/4D5N-BL7M] [hereinafter TurnKey Jet Incoming Letter]. endobj Though the SEC “trie[s] to pursue cases that deliver broad messages and have market impact beyond their own four corners,”64×64. 24 (2018) (statement of Jay Clayton, Chairman, SEC). (May 15, 2018), https://www.federalreserve.gov/newsevents/speech/brainard20180515a.htm [https://perma.cc/8DWS-CH5Q]. C. Reasonable Expectation of Profits Derived from the Efforts of Others Support for hundreds of cryptocurrencies & digital assets. Id. Cal. Seward, supra note 1. (internal citation omitted) (first quoting Blockvest, 2018 WL 6181408, at *7; and then quoting Warfield v. Alaniz, 569 F.3d 1015, 1021 (9th Cir. 2144, 116th Cong. {�0�t`��Ø���/TJ[� �c��о;�y�����|���U�r��+e"��o��rߔ��‹��������\��mp��[WZ������+������i�L�^�u�i�-�6o����5v�f�i�rOӵ6�����=�� �j����9�6�,�rOල?���ml���j���o�p��y����ޔl���O�ک3)c�����Ǫ?��m���|�|���r��*�������K�ܧ��o�����˽7�/�����@׽�E��O���g��4�#9�&� �� @-�����::���ă>����i���5>��,�3g�1��8�M� �G}���S��\��U������6X��i��Z�. The SEC scaled up enforcement by creating a cyber unit to specifically target “[v]iolations involving distributed ledger technology and initial coin offerings”22×22. (Jan. 27, 2019, 11:00 AM), https://www.wsj.com/articles/are-ico-tokens-securities-startup-wants-a-judge-to-decide-11548604800 [https://perma.cc/3VLG-YRFR]. In contrast to conventional forms of money, cryptocurrencies generally are not backed by a trusted institution and are not liabilities of any particular entity.5×5. But, again adding to the confusion and glossing over the regulatory nuances in the same Senate hearing, the Chairman unequivocally stated: “I believe every ICO I have seen is a security.”42×42. Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets” April 3, 2019 Blockchain and distributed ledger technology can catalyze a wide range of innovation. <>>> Id. In deciding not to bring an enforcement action, the SEC relied on, inter alia, findings that the project was “fully developed and operational,” the tokens were “immediately usable for their intended functionality,” and the tokens were “marketed in a manner that emphasize[d] the functionality of the [t]oken, and not the potential for the increase in [its] market value.”38×38. The SEC also seemed to conflate the regulation of tokens as cryptocurrencies with tokens as investment contracts. of Governors of the Fed. On April 3, 2019, the SEC released Staff Guidance titled “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which applies the factors set forth in SEC v. W.J. But, hedging slightly and adding to the ambiguity of whether the SEC would, as a policy, apply securities law to ICOs, the press release’s subtitle read: “U.S. Cal. H.R. Thus, the Securities Act of 193312×12. For instance, the SEC served Kik, a secure messaging platform, with a notice stating that Kin, Kik’s token for in-app purchases, should have been registered — but Kik claims “that Kin is a currency, not a security,” and “does not need to be registered.”59×59. Responding to David E. Pozen & Lina M. Khan, A Skeptical View of Information Fiduciaries. (Exchange Act) are not necessarily proper fits for regulating blockchain-based digital assets. TurnKey Jet Incoming Letter, supra note 35, at 2. at 296. the Supreme Court articulated a test to determine if a financial instrument was an investment contract, and therefore a security subject to the Securities Act and the Exchange Act. Paul Vigna et al., What Crypto Downturn? If you are considering an Initial Coin Offering, sometimes referred to as an “ICO,” or otherwise engaging in the offer, sale, or distribution of a digital asset, you need to consider whether the U.S. federal securities laws apply. Framework for “Investment Contract” Analysis of Digital Assets Introduction. of Corp. Peirce, supra note 15. While the SEC’s framework for analyzing digital assets is promising in that it indicates that not all blockchain-based digital assets will be treated as securities, clear guidance through judge-made bright-line rules or legislation may be inevitable and necessary in the ICO space. Id. In that sense, the SEC’s framework may be more about guiding judges’ analysis in future litigation than providing tools for an average market participant to evaluate her digital assets. (July 1, 2018, 1:26 PM), https://www.wsj.com/articles/what-crypto-downturn-ico-fundraising-surges-in-2018-1530466008 [https://perma.cc/NN27-NX9A]. Sept. 11, 2018). “Get your act together”: this was the pointed message that the Chairman of the Securities and Exchange Commission (SEC) delivered in a November 2018 interview to any startup funded by an initial coin offering (ICO).1×1. The framework and no-action letter indicate that the SEC is open to excluding some blockchain-based digital assets from securities regulations. The framework may be the SEC’s attempt to speak to judges more than to market participants as cases like those involving Kik and Blockvest reach maturity. 9, 2019), https://medium.com/@BlockchainAssoc/the-token-taxonomy-act-is-back-and-we-need-it-more-than-ever-d2cbf0154776 [https://perma.cc/FX5Q-DYBD]. However, in a reversal of the decision, in February 2019, Judge Curiel granted the agency’s renewed injunction bid, finding that the SEC had indeed made the case that Blockvest’s promotional materials constituted an offer of unregistered securities containing materially false statements.49×49. 18-cv-2287, 2018 WL 6181408. realized the SEC’s worst fears, as the court took away the SEC’s sole discretion to interpret which tokens should qualify as securities. he and REcoin initially stated by way of defense that they thought the whole scenario boiled down to a “lack of legal clarity as to when an ICO or a digital asset is a security.”28×28. L.J. Casting a wider aperture this time, the court reapplied the Howey test to find that the tokens were in fact securities and the promotional materials presented by the defendant concerning the ICO constituted a prima facie violation of the Securities Act.52×52. Id. In Howey, the owner of a Florida citrus grove proposed to sell a land interest to investors. Id. 11 0 obj See Yoav Vilner, The Case of Authorities vs. Kik: What Do We Know So Far?, Forbes (Feb. 18, 2019, 1:59 AM), https://www.forbes.com/sites/yoavvilner/2019/02/18/the-case-of-authorities-vs-kik-what-do-we-know-so-far/#7da29a631b86 [https://perma.cc/3USH-ZPAW]. I used a … Luis Urbina, SEC Brings Enforcement Action Against Two Companies Related to Initial Coin Offerings, Covington (Oct. 10, 2017), https://www.covfinancialservices.com/2017/10/sec-brings-enforcement-action-against-two-companies-related-to-initial-coin-offerings/ [https://perma.cc/8TY4-YR8D]. which is meant to “assist those seeking to comply with the U.S. federal securities laws.”3×3. Letter from James Prescott Curry, Counsel, TurnKey Jet, Inc., to Office of Chief Counsel, Div. This lack of backing likely contributes to the SEC’s fear of fraud in the ICO space.6×6. On April 9, 2019, Representative Warren Davidson reintroduced the Token Taxonomy Act in Congress with growing support and an expanded list of cosponsors.55×55. In conjunction with the framework, the SEC’s Division of Corporation Finance issued a no-action letter stating that tokens issued by TurnKey Jet (TKJ), an on-demand air charter service,35×35. 8 0 obj Amid a flurry of calls for more clarity within the cryptospace, two leading SEC crypto experts released a document this week called the Framework for Investment Contract Analysis of Digital Assets. Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets” April 4, 2019 April 26, 2019 admin 0 Comments Bill Hinman, Director of Division of Corporation Finance Id. <>>> The SEC’s new framework demonstrates the agency’s desire to provide clarity and, more importantly, acknowledges that some blockchain-based digital assets should not be treated as securities. See, e.g., Mayweather, Securities Act Release No. Framework for “Investment Contract” Analysis of Digital Assets, SEC, Division of Enforcement Annual Report, Platforms as Trustees: Information Fiduciaries and the Value of Analogy, https://www.coindesk.com/sec-jay-clayton-consensus-invest-video, https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets#_ednref9, https://www.sec.gov/news/public-statement/statement-framework-investment-contract-analysis-digital-assets, https://www.federalreserve.gov/newsevents/speech/brainard20180515a.htm, https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11, https://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-bulletin-initial-coin-offerings, https://www.sec.gov/news/speech/speech-hinman-061418, https://medium.com/@BlockchainAssoc/open-blockchain-networks-are-incredibly-transparent-and-its-good-public-policy-to-support-them-be1288a74ecd, https://www.wsj.com/articles/drone-regulators-struggle-to-keep-up-with-the-rapidly-growing-technology-1468202371, https://insights.som.yale.edu/insights/can-regulators-keep-up-with-fintech, https://www.sec.gov/news/speech/peirce-regulation-view-inside-machine, https://www.sec.gov/news/press-release/2017-176, https://www.bloomberg.com/news/articles/2018-11-15/first-fraud-case-for-initial-coin-offering-set-for-guilty-plea, https://www.bloomberg.com/news/articles/2018-09-11/u-s-judge-says-initial-coin-offering-covered-by-securities-law, https://www.covfinancialservices.com/2017/10/sec-brings-enforcement-action-against-two-companies-related-to-initial-coin-offerings/, https://www.sec.gov/news/press-release/2018-240, https://www.sec.gov/divisions/corpfin/cf-noaction/2019/turnkey-jet-040219-2a1-incoming.pdf, https://www.sec.gov/divisions/corpfin/cf-noaction/2019/turnkey-jet-040219-2a1.htm, https://www.sec.gov/news/press-release/2017-131, https://medium.com/@BlockchainAssoc/the-token-taxonomy-act-is-back-and-we-need-it-more-than-ever-d2cbf0154776, https://www.forbes.com/sites/yoavvilner/2019/02/18/the-case-of-authorities-vs-kik-what-do-we-know-so-far/#7da29a631b86, https://www.wsj.com/articles/are-ico-tokens-securities-startup-wants-a-judge-to-decide-11548604800, https://www.coindesk.com/sec-official-says-plain-english-guidance-on-icos-is-coming, https://www.wsj.com/articles/what-crypto-downturn-ico-fundraising-surges-in-2018-1530466008, https://www.sec.gov/files/enforcement-annual-report-2018.pdf. Profits can be, among other things, capital appreciation resulting from the development of the initial investment or business enterprise or a participation in earnings resulting from the use of purchasers' funds. Complaint at 2, SEC v. Blockvest, LLC, No. and brought its first ICO enforcement action for fraud against Maksim Zaslavskiy.23×23. SEC, supra note 2. Hester M. Peirce, Comm’r, SEC, Regulation: A View from Inside the Machine, Remarks at Protecting the Public While Fostering Innovation and Entrepreneurship: First Principles of Optimal Regulation (Feb. 8, 2019), https://www.sec.gov/news/speech/peirce-regulation-view-inside-machine [https://perma.cc/EQN2-PF5N] (acknowledging that “[t]oken offerings do not always map perfectly onto traditional securities offerings”). 328 U.S. 293 (1946). on Banking, Hous., and Urban Affairs, 115th Cong. endobj Apparently, it’s an analytical tool that will help ICO issuers sort out if they will do jail time or not. This framework is promising because it illustrates that the SEC is willing to exempt certain blockchain-based digital assets from being treated as securities. But this ambiguity was not an adequate shield. TurnKey Jet No-Action Letter, supra note 36. refers to the protocols and supporting infrastructure that allow computers in different locations to propose and validate transactions and update records in a synchronised way across a network.” Morten Bech & Rodney Garratt, Central Bank Cryptocurrencies, BIS Q. As institutional market participants enter the blockchain and cryptocurrency arena,43×43. Both documents are pre-requisite reads in order to get the full context of … On April 3, 2019, the SEC announced the framework it would use to determine whether a digital asset would be considered an “investment contract” in light of the Supreme Court’s ruling in SEC v. W.J. 15 U.S.C. 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Evident in a recent ICO case in the TKJ Letter focuses on factors that are. The blockchain and Cryptocurrency arena,43×43: //perma.cc/A8GV-6X7Y ] [ hereinafter TurnKey Jet, Inc., SEC.!
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