About Steven Lofchie

Steven Lofchie is Senior Fellow of Legal Studies at the Center for Financial Stability and Co-chairman of the Financial Services Department at Cadwalader, Wickersham & Taft LLP.

Monopoly Money: Facebook Executive Responds to Regulatory Concerns over Proposed Cryptocurrency

A Facebook executive responded to regulatory concerns over the company’s proposed blockchain-based cryptocurrency, “Libra.”

In testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs, Facebook subsidiary Calibra executive David Marcus emphasized that Facebook will not release Libra until it has addressed regulatory concerns and received the necessary approvals.

Mr. Marcus clarified that, among other things:

– Libra is like cash and will serve as a payment tool, “not as an investment”;

– Libra Reserve will be subject to its respective government’s monetary policies;

– Libra Association does not intend to compete with sovereign currencies or engage in the “monetary policy arena”;

– Facebook will hold a leadership role until the Libra network launches, after which Facebook will have the same voting power as all other members;

– Libra Association will be supervised by the Swiss Financial Markets Supervisory Authority and intends to register as a money services business with the Financial Crimes Enforcement Network;

– Libra will adhere to anti-money laundering and Bank Secrecy Act requirements; and

– Libra Association “cannot . . . and will not” monetize data from the blockchain.

Mr. Marcus outlined the structure and management of Calibra, established “to provide financial services using the Libra Blockchain.” Mr. Marcus distinguished Libra and Calibra, saying that the entities are separate and that they will not exchange individual customer data. Additionally, Mr. Marcus noted that, with exceptions, Calibra will not share customers’ accounts and financial information with Facebook, and that the information will not be used for ad targeting. Facebook said that Calibra will increase user activity on Facebook, thereby generating greater advertising revenue.

COMMENTARY / STEPHEN LOFCHIE

The principal point of the statement was to assert that Libra will be operated in full compliance with all relevant national laws. As to one of the key questions concerning whether Libra coins might be a “security,” Mr. Marcus stated that it would not be because “Libra is a payment tool, not an investment. People will not buy it to hold like they would a stock or bond, expecting it to pay income or increase its value. Libra is like cash.”

Notwithstanding Mr. Marcus’ assertion, Libra raises a number of very difficult (or at least unresolved) legal questions. Unlike “stablecoins” that are completely linked to the value of a single currency (they are just representations of bank deposits), it is intended that Libra will be backed by a reserve of a number of different currencies. The relative proportions of various currencies to be held in the reserve is uncertain. The fact that Libra is not simply a virtual dollar means that, at least under current law, each purchase and sale of a Libra could be a taxable event for U.S. taxpayers. There are also securities law issues raised by, for example, the fact that the determination of the assets to back a Libra will involve discretion as to the purchase and sale of securities.

From a business standpoint, Mr. Marcus suggests that the real market for Libra may be outside of the United States or of any developed economy. Rather, the market for Libra could be principally in countries where the local currency is volatile or where there is significant uncertainty as to the soundness of the banking system. That actually makes a good deal of sense. Consumers in the United States may not have much use in their daily lives for a currency tied to a global basket of other currencies and securities that fluctuates each day, even if not that much, against the dollar. On the other hand, consumers in Venezuela might find such a currency very appealing.

SEC Chair Jay Clayton Responds to Criticism of Reg. Best Interest

SEC Chair Jay Clayton refuted criticism of the SEC’s recently adopted rulemaking package designed to strengthen protections afforded retail investors on services provided by broker-dealers and investment advisers. The rulemaking package consists of (i) Regulation Best Interest (“Reg. BI”), (ii) the Form CRS Relationship Summary, (iii) an interpretation of investment advisers’ fiduciary duty (the “Fiduciary Interpretation”), and (iv) an interpretation of the “solely incidental” prong of the broker-dealer exclusion under the Advisers Act.

In a speech in Boston, Mr. Clayton responded to seven claims that he believes are inaccurate, asserting that:

1. It is unrealistic to believe that it is possible to eliminate all conflicts of interest, and Reg. BI goes as far as is practicable in addressing broker-dealer conflicts of interest.

2. Reg. BI’s principle-based approach is preferable to a more prescriptive approach to the definition of “best interest,” which assumes that it would be possible to identify the “best” transaction for a particular investor.

3. The Fiduciary Interpretation applicable to investment advisers does not weaken the existing fiduciary duty but, rather, codifies existing SEC practices.

4. The Fiduciary Interpretation does require advisers to “avoid” conflicts.

5. The standards of conduct requirements under Reg. BI and the Fiduciary Interpretation cannot be met by disclosures alone, but require that firms act in the best interest of their customers.

6. Imposing an ongoing monitoring requirement on broker-dealers would not enhance Reg. BI and effectively would impose on them the duty to act as investment advisers.

7. The Form CRS Relationship Summary, along with online education resources, will provide material assistance to retail investors in understanding the duties they are owed by financial service providers.

STEVEN LOFCHIE COMMENTARY

When Regulation Best Interest was proposed, then-Commissioner Stein dissented from the proposal, saying it did not go as far as the DOL’s Fiduciary Rule Proposal; and while Commissioner Jackson voted to allow the proposal to go forward, he also criticized it as not going far enough. This should have served as a warning to Chair Clayton than any regulation that he adopted short of an imitation of the DOL’s Fiduciary Rule was going to be the target of substantial criticism. Chair Clayton proceeded on the basis that there was some middle ground of compromise that would satisfy detractors. That was simply not going to be the case.

Now, in many respects, we have ended up with the worst of all possible situations: (i) the Reg. BI adopting release fails to make any strong intellectual argument for why it is not reasonable to expect that broker-dealers can be fiduciaries to their clients; (ii) Reg. BI fails to make any distinction between sophisticated and unsophisticated natural person clients (treating Warren Buffett no different from a high school dropout); (iii) Reg. BI imposes significant new obligations on broker-dealers that very well may reduce the willingness of broker-dealers to provide “full-service” brokerage to retail investors and instead result in retail investors seeking any level of advice to potentially pay a much higher charge to an investment adviser; (iv) Reg. BI fails to satisfy any of the critics who wanted a fiduciary obligation imposed on broker-dealers; and (v) states are adopting their own “suitability” rules – urged on by Commissioner Jackson – thereby moving U.S. securities regulation away from a unitary system of regulation to a fractured Brexit system. See generally Cadwalader memorandum: Choose One – Best Interest or Full Service (Apr. 26, 2018); see also SEC Adopts Regulation Best Interest (June 6, 2019).

SIFMA Dismisses State Fiduciary Proposal; Advocates for a Uniform Federal Standard

SIFMA criticized New Jersey’s proposal to create a state fiduciary standard, calling a federal standard the “optimal approach” compared with an “uneven patchwork” of state laws.

In a comment letter, SIFMA emphasized that Regulation Best Interest (“Reg. BI”) will better protect investors and avoid confusion, as compared to a state-by-state approach. According to SIFMA, New Jersey’s proposal would (i) impose costly and burdensome regulations on firms, (ii) incentivize firms to restrict their brokerage services in New Jersey and (iii) cause many middle-class investor to lose access to advice altogether.

Specifically, SIFMA stated that the proposal would:

create, in certain instances, a burdensome ongoing fiduciary duty;

establish an “impossible ‘best of’ standard for recommendations of account-types, asset transfers, purchases, sales or exchanges of securities, and transaction-based compensation”;

enact requirements duplicative of Reg. BI; and

fail to address certain common brokerage activities, such as principal trading.

SIFMA advised New Jersey to “substantially revis[e]” its proposal to avoid these potential consequences.

COMMENTARY / STEVEN LOFCHIE

The establishment of heavier federal and state burdens on broker-dealers providing clients with recommendations, combined with the potential great diversity of state regulation, is yet another blow to the business model of “full-service brokerage,” in which broker-dealers provide “suitable” recommendations to individual clients and are compensated by their receipt of securities execution fees. If broker-dealers are going to be tasked as fiduciaries in making any recommendation to investors, then they need to consider whether the economics of undertaking this obligation without being expressly compensated for it makes sense. (See generally the Cabinet memorandum Choose One – Best Interest or Full Service.)

Leaving aside the heavier burden the regulators would impose on broker-dealers, the complexity of a 50-state regulatory regime (combined with an already very complex regulatory regime) simply makes things worse for firms registered as broker-dealers. The number of broker-dealers will continue to decline, the ability of investors to obtain intermittent investment recommendations outside of a formal advisory relationship (and the associate fees) will continue to decline, and regulators will continue to bemoan the increased concentration of financial service firms (as if they were not a principal driving force of that concentration). (Cf. CFTC Commissioner Dan Berkovitz Wants Agency to Focus on Competition and Position Limits.)

Staying with the difficulties that will be created by a fifty-state regulatory regime, Commissioner Jackson’s dissent to the adoption of Regulation Best Interest was particularly disappointing. The Commissioner favored an even stricter regime imposed on broker-dealers than Regulation Best Interest provided. However, rather than accept the disappointment of the outcome, and perhaps win the day in another administration, he essentially advocated for each state to go its own way. While this may provide the Commissioner with what he believes to be a victory on this issue, the overall effect on the U.S. economy of this victory and others of a similar nature, not only in the area of financial regulation, is extremely damaging. In effect, it is advocating for a mini-Brexit, with each jurisdiction establishing its own regulatory regime, and so losing the benefit of a single unified market operating under a consistent sent of rules.

SEC Commissioner Hester Peirce Says SEC Will Closely Monitor Reg. BI Implementation

SEC Commissioner Hester M. Peirce urged critics “to take a fair look” at what Regulation Best Interest (“Reg. BI”) says before “proclaim[ing] it a success or failure.” She expressed the “agency’s commitment to monitor the [new rule] to ensure that investors in all income and wealth brackets are able to choose either a broker-dealer or an investment adviser.”

In a statement at the Open Meeting on Reg. BI and Related Actions, Ms. Peirce emphasized that there is more work to be done to ensure that the regulation helps investors without inflicting an unnecessary regulatory burden on broker-dealers. She asked firms to keep the SEC informed of any challenges or issues that arise throughout Reg. BI’s implementation. For example, Ms. Peirce raised concerns about small firms and broker-dealers who may be forced to change their names or registration status as a result of Reg. BI.

Ms. Peirce cautioned that the “very ambitious” compliance period will require firms to start their implementations immediately. Ms. Peirce said that the SEC should monitor Reg. BI’s implementation to ensure that, among other things, it does not exacerbate the trend of declining broker-dealers.

Additionally, Ms. Peirce noted improvements in the final Form CRS Relationship Summary and suggested ways to make disclosures more accessible. Specifically, Ms. Peirce encouraged the SEC to utilize online platforms and move away from paper-based documentation.

STEVEN LOFCHIE’S THOUGHTS…

Commissioner Peirce’s statement, while strongly in support of Reg. BI and the related rulemakings, nonetheless raises the issue as to whether the new requirements put further downward pressure on the full-service broker-dealer business model for retail investors. While it is certainly important for the agency to monitor the implementation process, and then determine whether the rule is properly calibrated to preserve the full-service business model, the practical reality is that if the rule has gone too far and materially damages the model, the damage done will likely not be reversible. It will take years of watching for the SEC to make any judgment as to the effect of Reg. BI on the full-service model (and any such judgment will be inherently subjective) and then it would take years more to make any rule revision. Businesses are much more easily destroyed than they are created.

SEC Commissioner Criticizes Agency for Limiting Investor Access to New Products

SEC Commissioner Hester Peirce criticized the agency for limiting investors’ access to new types of investment products. The Commissioner described very slow progress in formalizing and standardizing the treatment of relief for exchange-traded funds (“ETFs”).

In remarks at the ETFs Global Markets Roundtable, Ms. Peirce highlighted the benefits of ETFs in general, saying that they (i) provide investors with a range of investment options, (ii) are easy to enter and exit with low transaction fees and (iii) offer lower operating expenses relative to those of comparable mutual funds. Ms. Peirce observed that the SEC exercises caution with respect to approving new types of ETFs. She noted that the SEC just authorized its first non-fully transparent actively managed ETF after eight years of thinking about it.

Ms. Peirce urged the SEC to move forward with more speed on other requests for exemptive relief for projects. She criticized SEC “indecision” in the treatment of leveraged and inverse ETFs. Ms. Peirce said that after issuing several orders granting two sponsors permissions to operate as leveraged and inverse ETFs, the agency got “cold feet” and has not issued any other permissions. Ms. Peirce added that the agency’s reluctance to permit more competitors to offer geared ETFs is another instance of its curtailing access to an investment product that would be helpful to some investors.

In addition, Ms. Peirce proposed that the Division of Investment Management explore the marketplace’s interest in acquiring exposure to bitcoin and other cryptocurrencies through a registered investment company. She noted that although there is interest from investors and sponsors, the SEC has not yet granted an exemptive application for an ETF or approved a rule permitting the operation of crypto ETFs or other exchange-traded products. She emphasized that she did not believe such ETFs were necessarily a good investment, but added that it ought to be for the market and not the regulators to decide.

LOFCHIE COMMENTARY

Commissioner Peirce highlights fundamental questions that financial regulators must confront. Where should the line be drawn between protecting investors (effectively prohibiting them from buying a variety of risky products) and allowing investors to make their own decisions? This is not a binary decision; it is a line-drawing exercise.

Regulators tend to move toward protection rather than toward allowing investors to make their own decisions based on mandated disclosures. There is a fair amount of empirical evidence to suggest that such protectionism may be a good way to go, at least in the overall and aggregate scheme of things. This is, perhaps, even more true as holders of wealth age and become less capable of making sound decisions.

Yet depriving individuals of economic freedom has aspects that are worrisome. By way of managed ETFs, for example, the government may be depriving investors of choices that might be good for them. Should regulators discourage investors from taking such risk? Should riskier investments not be funded? Is society better or worse off?

Bigger picture, if adults cannot be trusted to make economic decisions, even on the basis of full disclosure, on what basis should they be trusted to make other decisions? By what logic are people who cannot be allowed to make reasonable economic decisions to be trusted to elect political decision makers? Where the line should be drawn is debatable, but permitting failure has to be an option.

OCC Underscores Risks Facing Federal Banking System

In its Semiannual Risk Perspective for Spring 2019, the OCC described the condition of banks as “strong” as far as capital, leverage and short-term performance. The regulators highlighted a number of significant big-picture risks, particularly as to AML compliance and operations and FinTech:

AML. AML-related deficiencies “stem from three primary causes: inadequate customer due diligence and enhanced due diligence, insufficient customer risk identification, and ineffective processes related to suspicious activity monitoring and reporting, including the timeliness and accuracy of Suspicious Activity Report filings. Talent acquisition and staff retention to manage [] compliance programs and associated operations present ongoing challenges, particularly at smaller regional and community banks.”
FinTech. “Rapid developments in FinTech and ‘big tech’ firms, evolving customer preferences, and the popularity of mobile technology applications have significantly changed the way banks operate and consumers conduct their banking and financial activity. . . . [T]he pace of change and the transformative nature of technology may result in a more complex operating environment. . . . Changing business models or offering new products and services can, however, elevate strategic risk when pursued without appropriate corporate governance and risk management. New products, services, or technologies can result in greater reliance on third parties by some banks and a concentration of service providers by the industry as a whole.”

LOFCHIE COMMENTARY

A key takeaway from the OCC’s regulatory comments is that the regulators expect that there is likely to be a material reduction in the number of smaller banks. They are squeezed on the expense end from compliance costs and new technology costs, and squeezed on the revenue end from competition with FinTech firms and customers’ disinterest in traditional banking relationships.

SIFMA AMG Supports FSOC “Activities-Based” Proposal for Combating Systemic Risks

In a comment letter, the SIFMA Asset Management Group (“SIFMA AMG”) expressed support for a proposal by the Financial Stability Oversight Council (“FSOC”) to change existing interpretive guidance to include adopting an “activities-based approach” to address systemic risk issues. Under the approach, FSOC would identify, evaluate and address potential risks to U.S. financial stability that arose from particular activities and would seek to adopt regulations applicable to those activities, rather than impose requirements on a single entity.

SIFMA AMG agreed that the proposed guidance would improve FSOC’s ability to identify and mitigate risks to U.S. financial stability. In order to better “enhance, clarify and refine the strong foundation” outlined in the proposed guidance, SIFMA AMG advised FSOC to:

– provide more details on how FSOC will conduct the “activities-based approach” process;
– confirm that any action by FSOC is triggered by a “reasonably foreseeable and likely set of facts and circumstances,” not simply by possible or potential situations or conditions;
– identify the level of scope and scale that indicates financial risks or threats to financial stability;
– strengthen the role of the primary financial regulator;
– explicitly state that it will solicit input from the industry;
– outline the “shortcomings” of the prior guidance and how the new approach will be better;
– clarify that the cost-benefit analysis requirement applies to recommendations for increased regulation and entity-based designations;
– state that it is responsible for the burden of proof in adopting any requirement;
reference existing rules or policies concerning “transmission channels” that relate to threats to U.S. financial stability;
– set more formalized procedures for the two-stage designation process and specify how it will treat confidential information;
separate functions of investigative and prosecutorial staffs and adjudicative bodies to ensure impartiality; and
– work with non-U.S. and international policymakers to harmonize rules and policies affecting the asset management industry.

LOFCHIE COMMENTARY

The FSOC move towards imposing restraints on a particular type of activity, rather on an individual entity, is extremely significant in preventing potential abuses of power. It will limit the ability of FSOC to single out a company that may be in the disfavor of the ruling political party. While this move is to the good, it would be better still if Congress would actually adopt legislation that would confine FSOC’s discretionary power rather than rely upon FSOC to police itself.

SEC Commissioner Hester Peirce Criticizes SEC for Lack of Clarity on Jurisdiction over ICOs

SEC Commissioner Hester M. Peirce criticized the SEC for failing to clarify how it applies the “Howey Test” (SEC v. W.J. Howey Co.) to digital assets used in initial coin offerings (“ICOs”).

Contrary to her prior concerns about the downside effects of overregulating the crypto industry, Ms. Peirce said that the SEC’s “unwillingness to take meaningful action” has actually “stifled” the industry.

In a speech at the Securities Enforcement Forum, Ms. Peirce analyzed the recent SEC guidance on digital assets, Ms. Peirce stating that its efforts to provide clarification have been generally unsuccessful. First, Ms. Peirce stated that the SEC staff’s Howey framework probably would only be understood by a “seasoned securities lawyer.” Specifically, while Howey has only four factors, the framework listed 38 considerations for determining whether a token offering is a securities offering.

Second, Ms. Peirce criticized the first token no-action letter, which gave the “false impression” that it was a “gray area of securities law.” As previously covered, the company TurnKey had been seeking to tokenize gift cards. The letter gave the impression that the securities law is more far-reaching than it is, according to Ms. Peirce, because the token was “clearly not an offer of securities.” Additionally, the letter highlighted non-dispositive factors and so, Ms. Peirce stated, “effectively imposed conditions on a non-security.”

Third, Ms. Peirce stated the SEC Division of Investment Management letter for advisers and funds on digital assets failed to provide meaningful guidance. Ms. Peirce conceded that the letter outlined certain questions that advisers should consider when buying and holding digital assets on behalf of their clients. However, she stated that it did not clarify how advisers can remain compliant with the Custody Rule.

Finally, Ms. Peirce warned that lack of regulatory clarification will push innovation into other jurisdictions.

LOFCHIE COMMENTARY

Commissioner Peirce continues to challenge the SEC’s lack of clarity on the application of the Howey test to ICOs. While it is true that the SEC did issue a position paper on the Howey Test and ICOs (SEC Publishes “Framework” for Determining if Digital Assets Are “Securities”), the purpose of the position paper seems largely to assert broad jurisdiction (lest the SEC be subject to the retrospective accusation of having missed something). In particular, the SEC in that position paper failed even to attempt to define the most important legal question under Howey; i.e., what constitutes a “common enterprise.”

At the same time that the SEC issued its position paper, the SEC staff issued a no-action letter holding that a particular crypto offering was not a “security.” See Subject to Strict Conditions, SEC Agrees that “Tokens” to Pay for Services Are Not “Securities”. This no-action letter did little to resolve the jurisdictional question as the tokens that were the subject of the letter very clearly fall into the class of “stable coins” that are completely linked to the value of the dollar on a one-for-one basis, and so there is no opportunity whatsoever for investment gain. In short, the SEC’s no-action letter simply addressed the most obvious possible case for admitting that it did not have jurisdiction, and failed to address any area of uncertainty.

SEC Proposes Improvements to Merger Disclosures

The SEC voted to propose rule amendments intended to improve the information disclosed regarding acquisitions and dispositions of businesses. The proposal is designed to facilitate access to capital in a more timely manner and to reduce the compliance burden of financial disclosures.

The proposed changes would, among other things:

– clarify the required determination of “significance” under the rule by revising the investment test and the income test, expanding the use of pro forma financial information in measuring significance, and conforming the significance threshold and tests for a disposed business;
– require the financial statements of the acquired business to cover up to the two most recent fiscal years rather than up to the three most recent fiscal years;
allow disclosure of financial statements that omit “certain expenses for certain acquisitions of a component of an entity”;
– provide guidance on when financial statements and pro forma financial information are required;
– authorize the use of, or reconciliation to, International Financial Reporting Standards;
– remove the separate acquired business financial statements requirement for businesses that have been included in the registrant’s post-acquisition financial statements for a complete fiscal year; and
– improve the content of the pro forma financial information requirements to reflect “reasonably estimable synergies and transaction effects.”

Specifically, the proposal would: (i) amend Rule 3-14 to align with Rule 3-05 where no unique industry considerations exist; ​(ii) clarify elements of Rule 3-14, including the “determination of significance, the need for interim income statements, special provisions for blind pool offerings, and the scope of the rule’s requirements”; (iii) codify smaller reporting company requirements in Article 8 of Regulation S-X; (iv) adopt a new Rule 6-11 and amend Form N-14 to include financial reporting for fund acquisitions by investment companies and business development companies; and (v) amend the definition of “significant subsidiary” for investment companies.

SEC Commissioner Robert J. Jackson Jr. voted to request public comment on the proposal, but urged commentators to propose improvements to the rules that would empower investors to hold executives more accountable for merger and acquisition disclosure. Commissioner Jackson cited “longstanding evidence” that corporate insiders use mergers to promote private interest over that of long-term investors. According to Mr. Jackson, the proposed rule amendments ignore this evidence and could lead to less disclosure about acquisitions by companies whose market value is significantly different from their book value. Additionally, Commissioner Jackson expressed concern that the economic analysis in the release ignores “the other half of [the] well-known equation: that acquiring companies’ stocks tend to take a hit upon the announcement of a merger.”

Comments must be submitted within 60 days of publication in the Federal Register.

LOFCHIE VIEW:

Judging by his statement, Commissioner Jackson appears to distrust corporate managers (i) when they keep profits within a company and use it to acquire another company and also (ii) when they disburse profits by buying back stock. See, e.g., SEC Commissioner Calls for Revision of Stock Buyback Rules. In general, a company that has more money than it can reasonably use for internal expansion must either use the money to buy something else or return it to shareholders. Here, Commissioner Jackson argues that “many mergers are not in investors’ long-term interests.” If the Commissioner is convinced of that, then there is inconsistency in his resistance to allowing issuers to give money back to their shareholders through stock buybacks. Even if a company can’t be too thin, it can be too (cash) rich.

SEC Agrees that “Tokens” to Pay for Services Are Not “Securities”

Commentary / Steven Lofchie

On the one hand, it is certainly a positive that the SEC is announcing an intellectual framework for determining whether a “digital asset” (perhaps better known as an “Initial Coin Offering” or “ICO”) is within the definition of the term “security.” On the other hand, the framework definitely casts a very broad net, which no doubt was intended.

As to the question of whether digital assets involve a “common enterprise,” the SEC simply says that “[b]ased on our experiences to date, investments in digital assets have constituted investments in a common enterprise because the fortunes of digital asset purchases have been linked to each other or the success of the promoter’s efforts” (at fn. 11). There is not much analysis there. One could, for example, argue that a digital newspaper subscription constitutes a digital asset because the value of the subscription is likely dependent upon the publisher’s ability to generate other subscriptions and thereby to turn out a good digital newspaper.

On the question of whether cryptocurrencies are securities, the framework says that, to fall outside of the definition, the digital asset must “actually operate as a store of value that can be saved, retried, and exchanged for something of value at a later time.” As to digital assets generally, “any economic benefit that may derived from appreciation [must be] incidental to obtaining the right to use [the asset] for its intended functionality.”

It is fairly well accepted that certain of the major cryptocurrencies are not securities. That said, it is not at all clear that any newly issued cryptocurrency would be able to meet the SEC’s conditions so as not to be a security.

Although the SEC has cast a very wide net with this analysis, it also published a no-action letter providing at least one example as to when a digital asset would not be a security. See SEC Staff Advises Turnkey Jet Tokens Are Not Securities.


The SEC provided a “framework for analysis” to help market participants evaluate whether the federal securities laws apply to the offer, sale or resale of a specific digital asset.

The framework is based on the “Howey” case, which found that a security exists where there is “[(i)] an investment of money [(ii)] in a common enterprise [(iii)] with a reasonable exception of profits [(iv)] to be derived from the efforts of others.” As to the first two elements, the SEC states that, generally, persons pay in some way for the digital asset and “in evaluating digital assets, [the SEC] has found that a ‘common enterprise’ typically exists.”

The report focuses on the third element, whether the purchaser of the asset may reasonably expect to profit from the purchase of the assets, (i.e., by having the expectation – or at least the hope – of selling the asset to someone else at a higher price); and the fourth element, whether the purchasers of the asset depend on the efforts of others (finding that they generally do, because a third party is creating and maintaining the technology).