April 3, 2019, marked two “firsts” for the SEC as they simultaneously released:
- A framework to help determine whether a digital asset offered in an initial coin offering (ICO) constitutes a securities offering and is therefore subject to U.S. securities laws; and
- A no-action letter clearing an ICO to sell tokens without registration under U.S. securities laws.
Together, these two actions begin to clarify how digital assets are, or are not, viewed in the eyes of the SEC.
Rather than reinvent existing U.S. securities laws, the SEC’s framework re-emphasizes the longstanding application of the Howey test to analyze whether a digital asset has the characteristics of an investment contract, and would therefore constitute a security. Under Howey, an investment contract exists when (a) money is invested in a (b) common enterprise with a (c) reasonable expectation of profits to be derived from the efforts of others.
Typically, most ICOs will meet the first two parts of the Howey test: an investment of money in a common enterprise. Most of the gray area in the analysis lies in evaluating the nuances of the ICO to determine whether or not there is a reasonable expectation of profits derived from the efforts of others. To aid in making this determination, the framework sets forth a variety of characteristics to consider, including, for example:
- Are the efforts of the promoter or sponsor of the digital asset impacting the development of a network and creating a market for the digital asset, and is it reasonable that a purchaser of the asset would rely on those efforts?
- Does the purchaser or holder of the digital asset have rights to share in income and appreciation derived from the asset?
- Is there an ability to trade or transfer the asset in a market or a future expectation to do so?
- Is the asset broadly marketed to purchasers, rather than being specifically tied to certain goods and services that may have been exchanged for the digital asset?
By applying the framework to examine each component of the Howey test, it is expected the majority of ICOs will be considered securities. This is further underscored by the no-action letter related to TurnKey Jet’s tokens, which details an extremely narrow use case in applying the framework to conclude an ICO does not represent a security offering.
While the industry has long awaited regulatory clarity from the SEC on digital assets, even with these recent developments what remains clear is that there is still a long way to go as this asset class continues to evolve.
Contact Corey McLaughlin at cmclaughlin@cohenco.com or a member of your service team for further discussion.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.
