United States: Corp Fin Issues White Paper And Related No-Action Letter Further Addressing When A Digital Asset Is A Security

On April 3, 2019, the Division of Corporation Finance of the Securities and Exchange Commission (“SEC” or the “Commission”), through its Strategic Hub for Innovation and Financial Technology (“FinHub”), issued a white paper titled “Framework for ‘Investment Contract’ Analysis of Digital Assets” (the “Framework”). On the same day, FinHub issued the first no-action letter recommending no enforcement action for a token offering. To see the Framework and the no-action letter, click here and here. The Framework is likely to disappoint those looking either for bright-line standards that would allow developers to be confident the digital assets they sell are not securities or for a new regulatory approach that would treat fewer token offerings as securities offerings.

The Framework

The Framework is a detailed analysis of digital assets using the investment contract analysis from SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Under the Howey test, an investment contract, and therefore a security, exists when there is (i) an investment of money (ii) in a common enterprise (iii) with a reasonable expectation of profits derived from the efforts of others. Commission staff members previously have presented this analysis regarding digital assets, most notably in the 2017 DAO Report and in Division of Corporation Finance Director William Hinman’s June 2018 speech. The Framework, however, is a more detailed discussion of the Howey test, with particular application to the offer and sale of digital assets for blockchain projects, networks and apps.

The Framework notes, without much discussion, that the first two prongs of the Howey test – an investment of money in a common enterprise – typically exist with offerings of digital assets. The Framework primarily analyzes the third prong of the Howey test – a reasonable expectation of profits derived from the efforts of others. As a threshold matter, the Framework introduces the notion of an “active participant” or “AP,” which is a promoter, sponsor or other third party that can be the provider of the “essential managerial efforts that affect the success of the enterprise” under Howey. The staff’s broad definition of AP seems to give the staff the ability to take the position that unconventional forms of managing or governing a network can satisfy the “managerial efforts of others” element of Howey.

The Framework lists 11 nonexclusive factors to use in evaluating whether a purchaser of digital assets is relying on the efforts of others. It lists 16 factors to use in evaluating whether a purchaser has a reasonable expectation of profits. In each case, the Framework notes that the more the listed factors are present, the more likely the applicable Howey element is met. Perhaps as important, the Framework notes that the courts have looked to the economic reality of the transaction and whether the instrument is offered and sold for use or consumption. The Framework lists 11 characteristics of use or consumption; the stronger their presence, the less likely the digital asset is a security. As with many multifactor legal analyses, the Framework notes that the factors are not intended to be exhaustive and no single factor is determinative.

The No-Action Letter

In a no-action letter issued on the same day the Framework was published, TurnKey Jet, Inc. (“TurnKey”) proposed to develop a token membership program and offer and sell blockchain-based tokens redeemable for air charter services. In light of the representations made by TurnKey in its request letter, the determination that the tokens were not securities was unremarkable. These included the following:

  • The funds from the token sales would not be used to develop a platform, network or apps (a “project”), and the project would be fully developed when the tokens are sold.
  • At the time of sale, the tokens could be used for the intended functionality – charter air services.
  • Tokens could be transferred only within the project’s wallet and not on external platforms or exchanges.
  • The tokens would be sold for $1.00 for the life of the program, and one token would represent a right to services worth $1.00.
  • If TurnKey offered to repurchase tokens, it would do so at a discount to the face value of $1.00.
  • The token would be marketed in a manner that emphasizes the functionality of the token and not the potential for an increase in value.

In light of TurnKey’s representations, it does not appear that it would have been difficult for the staff to conclude that the TurnKey tokens were not securities. Therefore, the TurnKey letter does not provide much comfort to others seeking to confirm that their tokens are not securities. The TurnKey letter, which merely confirms that it is possible to structure a token that is not a security, is a sort of bookend to the DAO Report cited above, which merely confirms that a token can be a security. In both cases, those conclusions were apparent to most practitioners paying attention, and they have not shed much light on the large gray area in between.

Summary

Taken together, the Framework and the TurnKey no-action letter confirm the staff’s prior position – developers seeking to raise capital through a token offering in order to finance the buildout of a network or project are likely to be selling a security. This will certainly be the case if the potential for appreciation or trading on a third-party platform is a significant feature of the token. While the Framework provides numerous factors to consider, unless and until the staff weighs in on specific, more nuanced applications of the Howey test to digital assets or provides additional guidance, we believe market participants and practitioners will continue to face difficult judgment calls when they apply the Howey test to digital assets.

In the Framework, the staff reiterates its willingness to consult with market participants through the FinHub portal to assist them in determining whether a particular digital asset is a security. Given the many factors involved in assessing that issue, we expect consultation with the SEC staff as to the securities law status of a particular proposed token offering to become the norm.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions