The Takeaway:
- The SEC’s new counsel outlines how it will apply the decades-old Howey test to crypto assets.
- However, there remain a number of unanswered have doubts, including how the broad definition of “active participants” might impact projects; how startups based overseas are impacted and when and how a souvenir might no longer be a security.
- While legal experts and industry participants see this as a positive first step, the consensus enter into the pictures to be that there are still many issues still to be discussed.
Well, it’s a start.
That was the general feeling lot blockchain lawyers and regulatory experts following the long-awaited release Wednesday of U.S. Securities and Exchange Commission (SEC) guidance for startups looking to edition tokens.
While the additional clarity was certainly welcome, the new framework is lacking in some key areas, these industry associates said. In particular, questions remain about how broadly this guidance applies and what startups can actually survive a remove away from the new framework.
The SEC published its “plain English” guidance nearly six months after William Hinman, the SEC Governor of Corporation Finance, announced the regulator was developing it. Speaking to CoinDesk Wednesday, Hinman said the guidance should be profitable for startups to determine whether their offerings qualify as securities.
“We try to give an example of what might be a security and also what sway not be. We’re also trying to say that we recognize in certain cases the instrument is offered and sold for actual use,” he said, adding:
“One device we’re trying to make clear in this analysis is that not one of these factors is dispositive, you have to look at the whole mix.”
What is more, Wednesday’s guidance is not legally binding.
The question of whether a token is a security is far more than academic, however. Because if a proof does meet the definition, it means the startup or blockchain project selling it must follow longstanding, expensive and onerous registration desiderata – and an issuer that fails to do so is breaking federal law.
With such high stakes, the SEC’s framework was not quite the clarifying detail many had hoped for.
“While it’s helpful and it’s good to see the SEC remains focused in this area, it’s not quite as useful as a law or a rule or in spite of formal guidance would be,” said Andrew Hinkes, an attorney with Carlton Fields and general counsel for the investment bank Athena Blockchain. “A lot of it is a reiteration of what the law is and has been.”
In any case, there are many new details in Wednesday’s document, he said, starting with the concept of “active participants” (APs). In the SEC’s guidance, functioning participants are broadly defined, and could be any entity which manages a project, but may also refer to promoters, sponsors or other third litigants which have an impact on the possible success of an enterprise.
The lack of specificity is worth noting, Hinkes said, go on increasing:
“This is a pretty broad and pretty flexibly defined group and by the look of this AP definition, you start to wonder, choice promoters be involved? Will independent activists or shareholders be determined to be APs and then swept into this analysis?”
Katherine Wu, a whilom director at Messari and policy commentator, told CoinDesk via email that the definition of “active participant” may pose scions for startups.
“Taken liberally, that definition could really impact and even hinder the process in which a memento project/start-up can decentralize itself,” she said.
Jake Chervinsky, an attorney with Kobre Kim, told CoinDesk via email that in his observe, the SEC used the term to make clear to projects that their tokens can qualify as securities even if the original evidence issuer is not involved with any expectation of profit.
“In other words, if Company A sells a token on the promise that purchasers wishes profit from Company B’s efforts, the token could still be a security even if Company A has nothing to do with the devise after the token is issued. I do think there could be some token projects in this situation,” he said.
The onus will-power be on Company A to watch for this sort of scenario, he added.
Precedents
The main precedent-setting question that remains unanswered, Hinkes said, is when do souvenirs no longer qualify as securities, and when would the SEC be able to make that determination.
Hailey Lennon, head of acceptable and regulatory affairs with bitFlyer USA, told CoinDesk that the guidance appears to be primarily summarizing “additional examinations for the industry” in terms of evaluating their token offerings.
“I believe today’s SEC Framework is intended to help the industry and distribute companies more factors to consider,” she said. Yet, referring to the agency’s decades-old method for determining whether something is a fastness, Lennon added:
“Today’s SEC Framework provides additional clarity but it does not give the industry all the answers. … The ‘Other Germane Considerations’ on page 9 and 10 illustrate that digital assets don’t fit neatly into the Howey test and there are additional particulars from cases that the industry needs to consider.”
Peter Van Valkenburgh, director of research at advocacy group Silver Center, told CoinDesk in a statement via a spokesperson that while the conclusion to the SEC’s guidance is not necessarily new, the fact that the regulator is “saying it innumerable clearly than ever” is still significant.
The guidance, in particular, helps startups and developers “who have done the quickly thing” know that they are in compliance, he said.
On the flip side, it will be interesting to see how the framework is used with admiration to future enforcement actions, said Philip Moustakis, an attorney with Seward and Kissel and formerly with the SEC’s Partition of Enforcement and Cyber Unit.
Lennon echoed his comments, saying that “these factors could be used to absolve additional enforcement actions down the road.”
Other questions
The framework also leaves unanswered other points about federal securities laws and their application to crypto tokens, Chervinsky said.
In particular, it is unclear whether souvenir sales conducted outside the U.S. fall under the SEC’s jurisdiction.
“It isn’t clear to me that crypto companies will be able to reach fearless conclusions about their compliance status through this framework alone,” he said.
It’s an issue that has been mentioned before. Speaking in New York in March, SEC Commissioner Hester Peirce explained that startups in other nations can unquestionably come into contact with U.S. securities laws without aiming to do so.
This raises the question of how and when the SEC should lay stress upon actions against startups outside the U.S., she said, explaining:
“If you’re reaching out to U.S. investors, you can come into contact with our guaranties laws. … When I see those kinds of enforcement cases, I often say to my colleagues, ‘all right, do we really expect someone who’s based somewhere, in India for standard, to be thinking about U.S. securities laws at all times?’ and I think that’s not reasonable.”
That being said, some startups do bloody deliberately reach out to U.S. investors, and in those cases, the startups must be careful as they “can easily come into connection with our laws,” she said.
Innovation
Unanswered questions aside, some said Wednesday’s guidance – and an accompanying dispatch to an individual company – might simply continue to stifle innovation in the space.
The same day as issuing the framework, the SEC also divulged its first-ever “no-action letter,” allowing TurnKey Jet LLC to initiate a token sale. Again, while the headline was a cause for gala, the startup was subject to heavy restrictions. (TurnKey went back and forth with the SEC for nearly a year before it take home the letter.)
“I would also be remiss if I didn’t note that the release of this framework was timed along with the … message,” Wu said. “In my opinion, the no-action letter is woefully inadequate to address questions for a lot of token projects, because the issue at disburse a deliver was akin to tokenizing airline miles; nothing super innovative there.”
Returning to the framework, Kristin Smith, the Mr Big of the Blockchain Association, a D.C.-based lobbying group, told CoinDesk in a statement that while the group appreciates that the SEC is looking at how to concentrate securities laws to the crypto space, “this guidance presents a framework that will stifle investment in and alteration of open blockchain networks in the United States.”
Still, Chervinsky said, the framework does provide a deep, through-and-through analysis of how the Howey test applies to digital assets, and is clearer than any statements the SEC has previously issued. Referring to the activity’s last major pronouncement on the matter nearly two years ago, he added:
“The Framework effectively replaces the DAO Report as the SEC’s go-to key for whether and when digital assets qualify as regulated securities, and by including a list of crypto-specific characteristics relevant to the Howey interpretation, the Framework is many times more helpful than the DAO Report ever was.”
Hinkes agreed, saying that the incident that the regulator is continuing to engage with the marketplace bodes well for the industry.
“It’s positive for the digital asset buy to see the regulators engage with the marketplace, to continue to bring better clarity to the marketplace and to me this is a positive sign for the energy even in the form of a statement that’s not a rule or guidance or a law,” Hinkes said.
William Hinman image via BankXRP/YouTube