With REcoin, Zaslavskiy “allegedly misrepresented [REcoin] had raised between $2 million and $4 million from investors when the actual amount [was] approximately $300,000.” Id. 8, 2019), https://medium.com/@BlockchainAssoc/open-blockchain-networks-are-incredibly-transparent-and-its-good-public-policy-to-support-them-be1288a74ecd [https://perma.cc/A5WF-AGBB]. 9 0 obj 8 0 obj of Corp. At this point, some market participants are so frustrated with the SEC’s nebulous guidance that they are explicitly requesting that courts intervene to provide clarity. A digital asset should be analyzed to determine whether it has the characteristics of any product that meets the definition of “security” under the … See, e.g., Michael J. de la Merced & Nathaniel Popper, JPMorgan Chase Moves to Be First Big U.S. Bank with Its Own Cryptocurrency, N.Y. Times (Feb. 14, 2019), https://nyti.ms/2EbTNMW [https://perma.cc/5JVP-UC8N]. For instance, SEC Chairman Jay Clayton expressed concern that, as cryptocurrency and ICO markets are “currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.” Public Statement, Jay Clayton, Chairman, SEC, Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017), https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11 [https://perma.cc/7UT9-4ARZ]. x��]َ=n�裡� ��F-� ���=��L�O�0��B-��N�n;��h�9��Dq�D�T�il*���_�3g��_~��K�h\t�m����˿����Hw������7l����_�t�����d���O�/$whmJw��ʷ�x�돗?|�#?~Î We might be able to draw clearer lines once we see more blockchain projects mature. 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. 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. Through selective enforcement of the most egregious fraud cases, the SEC has prevented judges from interpreting the application of securities laws to digital assets, leading to vague and nebulous regulation. Id. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Exchange Act Release No. Introduction 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,2 you need to consider whether the U.S. federal securities laws apply. It was also the first time a federal court determined that the SEC had not shown that a digital asset offered in an ICO was a security. Nikhilesh De & Aaron Stanley, SEC Official Says “Plain English” Guidance on ICOs Is Coming, Coindesk (Nov. 6, 2018, 1:05 PM), https://www.coindesk.com/sec-official-says-plain-english-guidance-on-icos-is-coming [https://perma.cc/SM5E-WC6M]. Enable your end-users to earn yield on their assets through lending and staking capabilities. TurnKey Jet Incoming Letter, supra note 35, at 2. Id. The ambiguity’s impact is evident in a recent ICO case in the Southern District of California. ICOs that are securities offerings, we should regulate them like we regulate securities offerings.”41×41. uncertainty” and provide the clarity “required to spur continued investment and innovation in this technology.”57×57. The characteristics identified in the framework as signaling when a digital asset may represent an investment contract are largely consistent with characteristics previously identified by Commission and the staff. 328 U.S. 293 (1946). Id. 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. 17-cr-647, 2018 WL 4346339, at *7–9 (E.D.N.Y. Id. Rather, the guide helps investors and companies determine the classification of a particular token. Howey Co. and subsequent case law.Howey found that an “investment contract” exists where there is an investment of money in a common enterprise with a reasonable expectation … 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. 10,578, 2018 WL 6266203 (Nov. 29, 2018). An ICO functions much like an initial public offering (IPO) as a means to raise capital to fund a new development or project.8×8. 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. SEC v. REcoin Grp. The report is titled Framework for “Investment Contract” Analysis of Digital Assets, and is prefaced by the following Public Statement framing it. 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. But there were neither diamonds nor real estate.26×26. Lael Brainard, Governor, Bd. Blockchain Ass’n, supra note 55. 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. The document isn’t an official SEC regulation. See H.R. endobj Reserve Sys., Cryptocurrencies, Digital Currencies, and Distributed Ledger Technologies: What Are We Learning? Id. By way of background, an ICO is a fundraising mechanism in which new projects sell their underlying cryptotokens in exchange for fiat currency (for example, cash) or cryptocurrency (for example, Bitcoin).7×7. While Director William Hinman promised “plain English” guidance,62×62. For all those market participants who were unclear as to whether or not their token constituted a security, on April 3, 2019, the SEC released its long-awaited guidance titled "Framework for 'Investment Contract' Analysis of Digital Assets"1 (the "Framework").The Framework represents the Staff's views and is not a rule, regulation or statement of the SEC. Feb. 14, 2019). 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. at 295. ; see also Complaint at 2–3, SEC v. REcoin Grp. Sources: Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets” Framework for “Investment Contract” Analysis of Digital Assets; Turnkey Jet No-Action Letter See William Hinman, Dir., Div. Price appreciation resulting solely from external market forces (such as general inflationary trends or the economy) impacting the supply and demand for an underlying … 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. Cal. 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. 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. The uncertain landscape likely dampens innovation in blockchain technology. 18-cv-2287, 2019 WL 625163, at *1 (S.D. As part of a continuing effort to assist those seeking to comply with the U.S. federal securities laws, FinHub is publishing a framework for analyzing whether a digital asset is offered and sold as an investment contract, and, therefore, is a security. SEC Makes Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets” Traders Magazine Online News, April 4, 2019 John D'Antona Jr. (July 10, 2016, 7:52 PM), https://www.wsj.com/articles/drone-regulators-struggle-to-keep-up-with-the-rapidly-growing-technology-1468202371 [https://perma.cc/5T95-6LJT]; Gary Stern, Can Regulators Keep Up with Fintech?, Yale Insights (Dec. 13, 2017), https://insights.som.yale.edu/insights/can-regulators-keep-up-with-fintech [https://perma.cc/Q5V6-D989]. (FinHub) attempted to provide some clarity by issuing a “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which provides a toolkit to apply the Howey test to digital assets.30×30. See Reuben Grinberg, Bitcoin: An Innovative Alternative Digital Currency, 4 Hastings Sci. (Securities Act) and the Securities Exchange Act of 193413×13. Zack Seward, WATCH: SEC Chairman Jay Clayton’s Full Consensus: Invest Interview, Coindesk (Nov. 28, 2018, 5:13 PM), https://www.coindesk.com/sec-jay-clayton-consensus-invest-video [https://perma.cc/9RZ4-G2WU]. The court disagreed with Zaslavskiy and held that neither the Exchange Act nor Rule 10b-5 was unconstitutionally vague as applied. 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. Responding to David E. Pozen & Lina M. Khan, A Skeptical View of Information Fiduciaries. The SEC has just released an 11-page statement with an analysis pertaining to digital assets being offered and sold as an investment contract. 3 0 obj Apparently, it’s an analytical tool that will help ICO issuers sort out if they will do jail time or not. <>>> Of course, the framework is just the SEC’s view on securities law question under federal law. Framework for “Investment Contract” Analysis of Digital Assets Introduction. 3, 2019), https://www.sec.gov/divisions/corpfin/cf-noaction/2019/turnkey-jet-040219-2a1.htm [https://perma.cc/A8GV-6X7Y] [hereinafter TurnKey Jet No-Action Letter]. 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. 1 0 obj H.R. 15 U.S.C. Blockchain and distributed ledger technology can catalyze a wide range of innovation. Howey Co., 328 U.S. 293 (1946), to determine whether a digital asset that is offered and sold is an investment contract under the federal securities laws. Oct. 3, 2018), ECF No. 7356, 115th Cong. Investor Bulletin: Initial Coin Offerings, Investor.gov (July 25, 2017), https://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-bulletin-initial-coin-offerings [https://perma.cc/TD62-SQSZ]. 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]. 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. (May 15, 2018), https://www.federalreserve.gov/newsevents/speech/brainard20180515a.htm [https://perma.cc/8DWS-CH5Q]. I used a … See, e.g., Andy Pasztor & Robert Wall, Drone Regulators Struggle to Keep Up with the Rapidly Growing Technology, Wall St. J. — and the SEC is no different as it attempts to capture ICOs in the Securities Act and the Exchange Act.15×15. Sept. 11, 2018). This framework is promising because it illustrates that the SEC is willing to exempt certain blockchain-based digital assets from being treated as securities. 15 U.S.C. of Div. Id. SEC, Division of Enforcement Annual Report 3 (2018), https://www.sec.gov/files/enforcement-annual-report-2018.pdf [https://perma.cc/3KPY-VNAK]. In SEC v. W.J. The SEC has applied the “investment contract” analysis outlined in the U.S. Supreme Court’s Howey case 3 to analyze whether a digital asset – an asset that is issued and transferred using distributed ledger or blockchain technology, including, but not limited to, so-called virtual currencies, coins and tokens – is a security. A threshold issue is whether the digital asset is a “security” under those … 13 0 obj Congress may provide more concrete guidance. of Corp. 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. at 5 (emphasis added). endobj <>>> Proponents of the bill believe that it would “eliminate . at 298–99. Howey Co.,18×18. 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. The second piece of guidance came in the form of a “Framework for ‘Investment Contract’ Analysis of Digital Assets” that is intended to … Press Release, SEC, SEC Announces Enforcement Initiatives to Combat Cyber-Based Threats and Protect Retail Investors (Sept. 25, 2017), https://www.sec.gov/news/press-release/2017-176 [https://perma.cc/36YJ-L28H]. Paul Vigna et al., What Crypto Downturn? See id. There are also state law analyses that need to be done. Although Zaslavskiy eventually pleaded guilty,27×27. Framework for “Investment Contract” Analysis of Digital Assets Introduction. 18-cv-2287, 2018 WL 4955837, at *7 (S.D. 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. ICO Fundraising Surges in 2018, Wall St. J. FinHub focuses on the third prong of the Howey test and provides an exhausting, but “not intended to be an exhaustive,”32×32. 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”). . A word for word reading and breakdown of the SEC framework for understanding what is a Security Token vs what is a Utility token. TurnKey Jet, Inc., SEC No-Action Letter (Apr. 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. See, e.g., Mayweather, Securities Act Release No. 24 (2018) (statement of Jay Clayton, Chairman, SEC). 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. Delay in drawing clear lines may actually allow more freedom for the technology to come into its own.”44×44. 1. and pivoted to his second ICO, tokens that were backed by diamond investments.25×25. Oct. 5 2018). 12 0 obj Cal. See H.R. C. Reasonable Expectation of Profits Derived from the Efforts of Others Id. Id. This outcome represented pushback from at least one court against the SEC Chairman’s warning that “[i]f you finance a venture with a token offering, you should start with the assumption that it is a security.”47×47. <>>> In Howey, the owner of a Florida citrus grove proposed to sell a land interest to investors. & Tech. Statement on "Framework for ‘Investment Contract' Analysis of Digital Assets" Bill Hinman, Director of Division of Corporation Finance Valerie Szczepanik, Senior Advisor for Digital Assets and Innovation. 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. Zaslavskiy started off his ICO scheme with REcoin, marketing it as “The First Ever Cryptocurrency Backed by Real Estate,”24×24. §§ 77b(a)(1), 78c(a)(10). See Paul Vigna & Dave Michaels, Are ICO Tokens Securities? 24,081, 2018 WL 1468815 (Mar. These statutes define a “security” as a commonly traded financial instrument, such as a note, stock, or bond.16×16. . 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 … But it is unclear how the typical startup should heed that warning as the ICO space has been burdened with regulatory ambiguity since its inception. The Court has since focused on the substance of the transaction, rather than the form, to determine the nature of the financial instrument.20×20. This distributed ledger mitigates information asymmetry concerns, which the SEC regulations are designed to protect against.11×11. Rather, the court stated that it had “objectively inquire[d] into the ‘terms of promotional materials, information, economic inducements or oral representations at the seminars,’ or in other words, [inquired] into the ‘character of the instrument or transaction offered’ to the ‘purchasers.’” Id. 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. SEC Makes Statement on Framework for Investment Contract Analysis of Digital Assets The U.S. regulator is publishing a framework for analyzing whether a digital asset is offered and sold as an investment contract, and, therefore, is a security. 17-cv-05725 (E.D.N.Y. But this approach leaves the majority of the industry in the lurch. 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 … Yield Platform. No. Support for hundreds of cryptocurrencies & digital assets. As a result, some market participants are calling for judicial intervention, and the framework may be geared more toward guiding judges’ analyses in inevitable litigation than equipping citizens to navigate ICOs. SEC, supra note 2. Thus, the Securities Act of 193312×12. 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. 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. See generally id. See Patricia Hurtado, First Initial Coin Offering Fraud Case Ends in Guilty Plea, Bloomberg (Nov. 15, 2018, 5:17 PM), https://www.bloomberg.com/news/articles/2018-11-15/first-fraud-case-for-initial-coin-offering-set-for-guilty-plea [https://perma.cc/L9R5-QGM3]; see also Patricia Hurtado et al., U.S. Judge Says Initial Coin Offering Covered by Securities Law, Bloomberg (Sept. 11, 2018, 11:48 AM), https://www.bloomberg.com/news/articles/2018-09-11/u-s-judge-says-initial-coin-offering-covered-by-securities-law [https://perma.cc/W2U4-D8GC]. <> 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. at 577–78. (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]. (emphasis added). 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. its selective enforcement approach and nebulous guidance foreshadows intervention. The SEC concluded that there was no team and the coin was backed by nothing, and it warned Zaslavskiy he was breaking the law. But this ambiguity was not an adequate shield. The Token Taxonomy Act now has five cosponsors. 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. TurnKey Jet No-Action Letter, supra note 36. Zaslavskiy promised huge returns and fabricated a “team of lawyers, professionals, brokers, and accountants” to raise hundreds of thousands of dollars from investors. When It Comes to Analyzing Utility Tokens, the SEC Staff’s “Framework for ‘Investment Contract’ Analysis of Digital Assets” May Be the Emperor Without Clothes (Or, Sometimes an Orange Is Just an Orange) (Part IV) Dec 18, 2019 See SEC v. Blockvest, LLC, No. TKJ members purchase blockchain-based tokens, which “decreases the settlement time and improves the efficiencies of paying for and obtaining air charter services.”37×37. Agencies often struggle to capture emerging technologies in dusty regulatory frameworks14×14. 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. (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]. 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. [xii] In the Framework, the SEC staff appears to acknowledge that the inquiry into whether a particular instrument constitutes an “investment contract” is “an objective one, focused on the transaction itself and the manner in which the digital asset is offered and sold…The focus of the Howey analysis is not only on the form and terms of the instrument itself (in this case, the digital … . 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. For instance, when the SEC announced that it would apply the Howey test to tokens, the SEC’s press release title read: “SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities.”39×39. <> stream Framework for “Investment Contract” Analysis of Digital Assets1 I. 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. Startup Wants a Judge to Decide, Wall St. J. Cryptocurrencies, like Bitcoin, are digital currencies that depend on cryptography to verify and secure transactions, as well as to manage the creation of new units.4×4. The agency may delay providing clarity by all but ensuring that judges do not get the chance to draw bright-line rules. 1. Cal. The SEC’s decision not to classify TKJ tokens as securities further supports the conclusion that the SEC is providing a functional space for blockchain-based assets to operate. 26, 2018). endobj A court ruling on this particular case “could help determine the scope of the SEC’s authority to tame the unruly ICO market.”60×60. 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. at *7, *9. Judge Curiel “agree[d] with the SEC that the Howey test is unquestionably an objective one”50×50. %���� 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]. on Banking, Hous., and Urban Affairs, 115th Cong. Id. For instance, the guidance suggests looking at an active participant’s managerial role, the functionality and progress of the project, and the quantity of the funds raised.34×34. §§ 78a–78pp. Found., Litigation Release No. 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. Back, and the underlying source information is open to any market participant.10×10 of!, LLC48×48 Pozen & Lina M. Khan, a Skeptical view of information Fiduciaries a. Note 3 interest to investors is just the SEC ’ s guidance in the past from. 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