Two commissioners at the US SEC have published digital asset guidelines to help those launching or investing in various cryptos decide whether they fall under existing securities legislation. Whilst not an official SEC ruling, the commissioners behind the guidelines hope that they will aid market participants in determining the legality of a digital asset investment opportunity.
Many market participants in the digital currency space have previously demanded greater clarity from the SEC with regards the classification of digital currencies as securities. The guidelines published today should go someway to appeasing them.
SEC Staff Publish Guidelines on Crypto Assets as “Investment Contracts”
The guidelines were published today by Securities and Exchange Commissioners Bill Hinman and Valerie Szczepanik. The document, titled Framework for ‘Investment Contract’ Analysis of Digital Assets, seeks to clarify how to determine whether a given digital currency will be deemed by the Securities and Exchange Commission as an investment contract, and thus would fall under federal securities laws.
In an accompanying document, the authors are keen to point out that the guidelines are by no means complete and should not serve as legal advice. For this reason, Hinman and Szczepanik state that the SEC’s FinHub should be consulted for more formal, up-to-date regulations regarding the space.
The guidelines only focus on the classification of digital assets as one type of security – an investment contract. For this, the authors state that the long-established Howey Test should be used.
The Howey Test states that an investment contract exists when an investment is made in a common enterprise with the expectation of profiting from the actions of others. The guidelines go on to explain how the Howey Test can be applied to crypto and in particular initial coin offerings.
The investment in a common enterprise aspect of the Howey Test is usually satisfied with cryptocurrency offerings, according to the SEC authors. However, “a reasonable expectation of profits derived from the efforts of others” is much harder to quantify.
Much of the guidelines’ content is dedicated to this topic. Many different examples are put forward for how the “efforts of others” in a cryptocurrency project could add to the value of an initial investment. It states that no one of the listed criteria are necessarily enough to guarantee that buying a given digital asset is indeed deemed an investment contract. However, the presence of multiple of the characteristics means it is much more likely to be.
Some of the examples provided include:
- Where the digital asset was still in development at the time of the sale.
- Where an active participant in the project gets to determine where funds raised from the sale of a digital asset are spent.
- Where an active participant controls the total supply of an asset through creation or burning of tokens.
Likewise, the “reasonable expectation of profits” clause of the Howey Test seems appropriate to many crypto projects, particularly the guideline:
“The opportunity may result from appreciation in the value of the digital asset that comes, at least in part, from the operation, promotion, improvement, or other positive developments in the network, particularly if there is a secondary trading market that enables digital asset holders to resell their digital assets and realize gains.”
There are numerous other examples listed, which seem to create the impression that huge numbers of crypto projects may be in violation of US securities laws since they were not registered with the commission at the time of ICO and the nature of the assets’ distribution means it could be classified under existing federal legislation as an investment contract. However, Bitcoin, being organically launched and developed in a decentralised fashion seems exempt from the current securities laws.
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