New SEC Guidance: Cryptocurrencies are Not “Securities” (but Sometimes They are)
In mid-June, 2018, William Hinman, Director of Corporate Finance for the Securities and Exchange Commission (“SEC”), offered new guidance on the question of whether cryptocurrencies are “securities.” See news report here.
Previous guidance and SEC enforcement actions had suggested that cryptocurrencies ARE “securities,” and, as such, are subject to various laws like the Securities Act of 1933. However, in a recent speech, Hinman explicitly stated that Ether, the second largest cryptocurrency behind Bitcoin, is NOT a security. Basically, once a cryptocurrency or any type of asset reaches a certain level of decentralization and widespread distribution, that type of asset moves beyond purview of the SEC and securities laws. At the same time, sometimes and under some circumstances, a given cryptocurrency will be considered a “security.” Here is a quick overview.
San Diego Securities Law and Regulation D: Initial Cryptocurrency Offering Likely a Security
Hinman clarified that the SEC generally considers initial coin offerings (“ICO”) to be “securities” because, most often, the promoters of the new cryptocurrency are raising funds and engaged in marketing practices aimed at creating a secondary investment market. As reported, Hinman stated that such offerings have the same “economic substance … as a conventional securities offering.” The offering is generally widely promoted and advertised, the investors are typically expecting a return on their money, investors are also typically passive investors and relying on the promoters to create the market, complete the software, and otherwise make a success out of the offering. Those are the commonly accepted hallmarks of a securities offering. For these reasons, most ICOs will likely receive a critical viewing from the SEC.
However, where the cryptocurrency is no longer being offered by a central enterprise for purposes of raising investment funds OR where the cryptocurrency is sold only as an exchange vehicle — a currency — to be used to purchase goods or services, then the cryptocurrency may cease to be a “security” as defined by the SEC. According to Hinman, Ether is now in that category.
San Diego Securities Law and Regulation D: Howey Test
As we have discussed previously here, the SEC’s approach to cryptocurrencies is consistent with long-standing SEC and federal court analysis. The general test for whether something is considered a “security” is what is called the Howey test. See S.E.C. v. Howey Co., 328 U.S. 293 (US Supreme Court 1946). Under the Howey analysis, if an offering satisfies these three elements, then the offering is a “security”:
- An investment of money
- A common enterprise
- With an expectation of profits predominantly from the efforts of others
A quick look at the test shows that factor or prong #2 disappears as a cryptocurrency gains widespread and decentralized distribution. As a side note, Hinman’s recent statements are consistent with the previous guidance issued by the SEC. In December 2017, for example, the SEC stated that the Howey test would be central to determining if an ICO was subject to regulation by the SEC. See here.
Contact San Diego Corporate Law
For further information, contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard provides legal services related to private securities offerings/sales under Regulation D, the sale/purchase of a business, and related to mergers and acquisitions. Contact Mr. Leonard via email or by calling (858) 483-9200.