We encourage market participants to seek the advice of securities counsel and engage with the Staff through www.sec.gov/finhub. There is little apparent correlation between the purchase/offering price of the digital asset and the market price of the particular goods or services that can be acquired in exchange for the digital asset. While this framework did not rise to the level of an official statement by the SEC, it generated a lot of excitement in the industry. There is little apparent correlation between quantities the digital asset typically trades in (or the amounts that purchasers typically purchase) and the amount of the underlying goods or services a typical consumer would purchase for use or consumption. The promise (implied or explicit) to build a business or operation as opposed to delivering currently available goods or services for use on an existing network. 10530 (Aug. 14, 2018) (issuance of tokens under a so-called “bounty program” constituted an offer and sale of securities because the issuer provided tokens to investors in exchange for services designed to advance the issuer’s economic interests and foster a trading market for its securities). In these instances, purchasers would reasonably expect the AP to undertake efforts to promote its own interests and enhance the value of the network or digital asset. . The report is titled Framework for “Investment Contract” Analysis of Digital Assets, and is prefaced by the following Public Statement framing it. In this guidance, we provide a framework for analyzing whether a digital asset has the characteristics of one particular type of security—an “investment contract.” [4] Both the Commission and the federal courts frequently use the “investment contract” analysis to determine whether unique or novel instruments or arrangements, such as digital assets, are securities subject to the federal securities laws. It is not an exhaustive treatment of the legal and regulatory issues relevant to conducting an analysis of whether a product is a security, including an investment contract analysis with respect to digital assets generally. [8] Absent the disclosures required by law about those efforts and the progress and prospects of the enterprise, significant informational asymmetries may exist between the management and promoters of the enterprise on the one hand, and investors and prospective investors on the other hand. � �\_�g�9��Ǒ@E�$Ѝ ʡ��gL� .t�!J)��l���O�I��:;×�j�TImOc The Framework focuses on two key issues in analyzing whether purchasers of digital assets or tokens are relying on the efforts of others: (1) Does the … The SEC published a Framework for Investment Contract Analysis of Digital Assets on April 3, 2019. (go back), 6Whether a contract, scheme, or transaction is an investment contract is a matter of federal, not state, law and does not turn on whether there is a formal contract between parties. The document isn’t an official SEC regulation. The digital asset is marketed in terms that indicate it is an investment or that the solicited holders are investors. denied, 414 U.S. 821, 94 S. Ct. 117, 38 L. Ed. 88 0 obj <> endobj Are those efforts “the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise,”. The reduction of these information asymmetries through required disclosures protects investors and is one of the primary purposes of the federal securities laws. When it Comes to Analyzing Utility Tokens, the SEC Staff’s “Framework for ‘Investment Contract’ Analysis of Digital Assets” May Be the Emperor Without Clothes (Or, Sometimes an Orange Is Just an Orange) (Part I) Oct 28, 2019 108 0 obj <>stream Holders of the digital asset are immediately able to use it for its intended functionality on the network, particularly where there are built-in incentives to encourage such use. SEC Framework for “Investment Contract” Analysis of Digital Assets On April 3, 2019, the SEC’s FinHub released a “Framework for ‘Investment Contract’ Analysis of Digital Assets.”1 The Framework is the SEC staff’s most detailed pronouncement to date on when the staff would consider Initial Coin Offerings 1This framework represents the views of the Strategic Hub for Innovation and Financial Technology (“FinHub,” the “Staff,” or “we”) of the Securities and Exchange Commission (the “Commission”). Whether any economic benefit that may be derived from appreciation in the value of the digital asset is incidental to obtaining the right to use it for its intended functionality. To show the markets that the Securities and Exchange Commission is not just about slapping around wrong-doers, but also trying to help people navigate the securities laws, the SEC’s FinHub published a framework for analyzing whether a digital asset is a security. A digital asset should be analyzed to determine whether it has the characteristics of any product that meets the definition of “security” under the federal securities laws. No AP has access to material, non-public information or could otherwise be deemed to hold material inside information about the digital asset. Rather, under the Howey test, “form [is] disregarded for substance and the emphasis [is] on economic reality.” Howey, 328 U.S. at 298. On April 3, 2019, the SEC released Staff Guidance titled “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which applies the factors set forth in SEC v. W.J. Both documents are pre-requisite reads in order to get the full context of my remarks below. 2. When It Comes to Analyzing Utility Tokens, the SEC Staff’s “Framework for ‘Investment Contract’ Analysis of Digital Assets” May Be the Emperor Without Clothes (Or, … [20] In doing so, the courts also have considered whether the instrument is offered and sold for use or consumption by purchasers. Any economic benefit that may be derived from appreciation in the value of the digital asset is incidental to obtaining the right to use it for its intended functionality. Determining who will receive additional digital assets and under what conditions. Amid a flurry of calls for more clarity within the cryptospace, two leading SEC crypto experts released a documen t this week called the Framework for Investment Contract Analysis of Digital Assets. The availability of a market for the trading of the digital asset, particularly where the AP implicitly or explicitly promises to create or otherwise support a trading market for the digital asset. 81, 87-88 (2d Cir. We address each of the elements of the Howey test below. v. W. J. Howey Co., 328 U.S. 293 (1946) to digital assets. If the AP facilitates the creation of a secondary market, transfers of the digital asset may only be made by and among users of the platform. 81207) (July 25, 2017) (“The DAO Report”); William Hinman, Digital Asset Transactions: When Howey Met Gary (Plastic), Remarks at the Yahoo Finance All Markets Summit: Crypto (June 14, 2018), available at https://www.sec.gov/news/speech/speech-hinman-061418. Are those efforts "the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise,"as opposed to efforts that are more ministerial in nature? %PDF-1.6 %���� On December 11, 2017, SEC Chairman Jay Clayton noted that whether a digital asset is a security "will depend on the characteristics and use of that particular asset." Relevant factors may include: There is a correlation between the purchase price of the digital asset and a market price of the particular good or service for which it may be redeemed or exchanged. The framework was cobbled together by SEC Commissioners Valerie Szczepanik, Senior Advisor for Digital Assets and Innovation aka “crypto czar” and Bill Hinman, director of the SEC’s Division of Corporation Finance. The Framework states that an investment in a digital asset would usually constitute an investment in a common enterprise because " the fortunes of digital asset purchasers have been linked to each other or to the success of the promoter's efforts " 13. Does the purchaser reasonably expect to rely on the efforts of an AP? The federal securities laws require all offers and sales of securities, including those involving a digital asset, to either be registered under its provisions or to qualify for an exemption from registration. . Purchasers reasonably would expect that an AP’s efforts will result in capital appreciation of the digital asset and therefore be able to earn a return on their purchase. �- @��]�\�?�3`�`� �2�i�;��h��� |弙;[��l̊>�'Lݠ�$���� �J�[�P;�D�� ��H�j�$��#g4��>�쎀�6� �� �@S0��� PEG�`���� B|�r���t�4;�W � ��ˬ�Uzs�N}nN�-F��� �u��N2B����99H3q�005C��� ��U� 2d 53 (1973) (“Turner”). On April 3, 2019, the SEC’s Strategic Hub for Innovation and Financial Technology (“FinHub”) 1 published a framework for analyzing whether a digital asset is offered and sold as an investment contract and, therefore, is a security (the “Framework”). [4] The new FinHub framework delivers on that announcement, providing a useful analytical tool for … Making or contributing to managerial level business decisions, such as how to deploy funds raised from sales of the digital asset. Last week, the US Securities and Exchange Commission (SEC) through its strategic hub for financial innovation, FinHub, published a framework for analyzing whether a digital asset will be treated as a security under the oft cited Howey test. See, e.g., Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (Exchange Act Rel. Although no one of the following characteristics is necessarily determinative, the stronger their presence, the more likely it is that a purch… For example, it is offered and purchased in quantities significantly greater than any likely user would reasonably need, or so small as to make actual use of the asset in the network impractical. 0 In this guidance, we provide a framework for analyzing whether a digital asset is an investment contract and whether offers and sales of a digital asset are securities transactions. On April 3, 2019, the SEC announced the framework it would use to determine whether a digital asset would be considered an “investment contract” in light of the Supreme Court’s ruling in SEC v. W.J. (go back), 5SEC v. W.J. The digital asset is marketed, directly or indirectly, using any of the following: The expertise of an AP or its ability to build or grow the value of the network or digital asset. As noted above, under the Howey test, an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of … (FinHub) attempted to provide some clarity by issuing a “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which provides a toolkit to apply the Howey test to digital assets… Also, no one factor is necessarily dispositive as to whether or not an investment contract exists. Whether or not the efforts of an AP, including any successor AP, continue to be important to the value of an investment in the digital asset. For example, the design of the digital asset provides that its value will remain constant or even degrade over time, and, therefore, a reasonable purchaser would not be expected to hold the digital asset for extended periods as an investment. �%Փ4_`�ժ�gL{�s��( In a so-called “airdrop,” a digital asset is distributed to holders of another digital asset, typically to promote its circulation. As part of a continuing effort to assist those seeking to comply with the U.S. federal securities laws, FinHub is publishing a framework for analyzing whether a digital asset is offered and sold as an investment contract, and, therefore, is a security. [7] This is true in the case of a corporation, for example, but also may be true for other types of enterprises regardless of their organizational structure or form. For example, purchasers may reasonably rely on an AP for liquidity, such as where the AP has arranged, or promised to arrange for, the trading of the digital asset on a secondary market or platform. The digital asset gives the holder rights to share in the enterprise’s income or profits or to realize gain from capital appreciation of the digital asset. The digital asset is available in increments that correlate with a consumptive intent versus an investment or speculative purpose. (go back), Posted by Tami Groswald Ozery, Harvard Law School Program on Corporate Governance, on, Harvard Law School Forum on Corporate Governance, on Framework for “Investment Contract” Analysis of Digital Assets. Profits can be, among other things, capital appreciation resulting from the development of the initial investment or business enterprise or a participation in earnings resulting from the use of purchasers’ funds. 97 0 obj <>/Filter/FlateDecode/ID[<2316C906D61ED7488A91FD10B5249514>]/Index[88 21]/Info 87 0 R/Length 68/Prev 226202/Root 89 0 R/Size 109/Type/XRef/W[1 3 1]>>stream Restrictions on the transferability of the digital asset are consistent with the asset’s use and not facilitating a speculative market. endstream endobj startxref The digital asset is transferable or traded on or through a secondary market or platform, or is expected to be in the future. This can be demonstrated, for example, if the AP retains a stake or interest in the digital asset. If it is characterized as a virtual currency, the digital asset actually operates as a store of value that can be saved, retrieved, and exchanged for something of value at a later time. Therefore, issuers and other persons and entities engaged in the marketing, offer, sale, resale, or distribution of any digital asset will need to analyze the relevant transactions to determine if the federal securities laws apply. The value of the digital asset has shown a direct and stable correlation to the value of the good or service for which it may be exchanged or redeemed. Last November, Corporation Finance Director William Hinman announced plans to release "plain English" guidance to help developers determine whether any potential digital asset offering may be classified as a securities transaction. Framework for Investment Contract Analysis of Digital Asset Transactions. [18] Price appreciation resulting solely from external market forces (such as general inflationary trends or the economy) impacting the supply and demand for an underlying asset generally is not considered “profit” under the Howey test. Making other managerial judgements or decisions that will directly or indirectly impact the success of the network or the value of the digital asset generally. A threshold issue is whether the digital asset is a “security” under those laws. The digital asset is offered broadly to potential purchasers as compared to being targeted to expected users of the goods or services or those who have a need for the functionality of the network. For example, the digital asset can only be used on the network and generally can be held or transferred only in amounts that correspond to a purchaser’s expected use. 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. Playing a leading role in the validation or confirmation of transactions on the network, or in some other way having responsibility for the ongoing security of the network. See discussion of “Other Relevant Considerations.”(go back), 20As noted above, under Howey, courts conduct an objective inquiry focused on the transaction itself and the manner in which it is offered. The AP monetizes the value of the digital asset, especially where the digital asset has limited functionality. The intended use of the proceeds from the sale of the digital asset is to develop the network or digital asset. The following characteristics are especially relevant in an analysis of whether the third prong of the Howey test is satisfied. See also United Housing Found., Inc. v. Forman, 421 U.S. 837 (1975) (“Forman”); Tcherepnin v. Knight, 389 U.S. 332 (1967) (“Tcherepnin”); SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344 (1943) (“Joiner”). In this guidance, we provide a framework for analyzing whether a digital asset is an investment contract and whether offers and sales of a digital asset are securities transactions. That a scheme assigns “nominal or limited responsibilities to the [investor] does not negate the existence of an investment contract.” SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 483 n.15 (5th Cir. An AP is responsible for the development, improvement (or enhancement), operation, or promotion of the network. "As part of a continuing effort to assist those seeking to comply with the U.S. federal securities laws, FinHub is publishing a framework for analyzing whether a digital asset is offered and sold as an investment contract, and, therefore, is a security. (go back), 21See Forman, 421 U.S. at 852-53 (where a purchaser is not “’attracted solely by the prospects of a return’ on his investment . An AP has a lead or central role in the direction of the ongoing development of the network or the digital asset. Howey Co. As the Commission explained in The DAO Report, “[i]n determining whether an investment contract exists, the investment of ‘money’ need not take the form of cash” and “in spite of Howey’s reference to an ‘investment of money,’ it is well established that cash is not the only form of contribution or investment that will create an investment contract.” The DAO Report at 11 (citation omitted). A purchaser may expect to realize a return through participating in distributions or through other methods of realizing appreciation on the asset, such as selling at a gain in a secondary market. Rather, the guide helps investors and companies determine the classification of a particular token. the securities laws do not apply.”). 488, 496 n.13 (Apr. (go back), 16We recognize that holders of digital assets may put forth some effort in the operations of the network, but those efforts do not negate the fact that the holders of digital assets are relying on the efforts of the AP. 1985). (go back), 17See, e.g., Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce Fenner & Smith, 756 F.2d 230 (2d Cir. Whether holders are then able to use the digital asset for its intended functionality, such as to acquire goods and services on or through the network or platform. Purchasers of the digital asset no longer reasonably expect that continued development efforts of an AP will be a key factor for determining the value of the digital asset. As noted above, under the Howey test, an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. The digital asset is marketed in a manner that emphasizes the functionality of the digital asset, and not the potential for the increase in market value of the digital asset. The retailer creates a digital asset to be used by consumers to purchase products only on the retailer’s network, offers the digital asset for sale in exchange for real currency, and the digital asset is redeemable for products commensurately priced in that real currency. Usually, the main issue in analyzing a digital asset under the Howey test is whether a purchaser has a reasonable expectation of profits (or other financial returns) derived from the efforts of others. The AP owns or controls ownership of intellectual property rights of the network or digital asset, directly or indirectly. The AP is able to benefit from its efforts as a result of holding the same class of digital assets as those being distributed to the public. There are essential tasks or responsibilities performed and expected to be performed by an AP, rather than an unaffiliated, dispersed community of network users (commonly known as a “decentralized” network). With respect to a digital asset referred to as a virtual currency, it can immediately be used to make payments in a wide variety of contexts, or acts as a substitute for real (or fiat) currency. Howey Co., 328 U.S. 293 (1946) (“Howey”). Further, the lack of monetary consideration for digital assets, such as those distributed via a so- called “air drop,” does not mean that the investment of money prong is not satisfied; therefore, an airdrop may constitute a sale or distribution of securities. The trading volume for the digital asset corresponds to the level of demand for the good or service for which it may be exchanged or redeemed. hޤUmO�0�+�� �$q Uj��M�U$��ⵑҤJ����|vi This means that it is possible to pay for goods or services with the digital asset without first having to convert it to another digital asset or real currency. The distributed ledger network and digital asset are fully developed and operational. �P���Z�Sj���9�{����������B���%��m��΂�ֈų?������Y��m���`�������%�^���0W��}s���e��gᾡ9΂ =���ý b-��,w8M3�f�e�3�~�������,�`Բ0zY�4x��d�w�o�sv�FnQ;o���mV��\a����CD�ꁺz`�z��!��ت�Q���VoT������t�>�ٻ'��m����j����Q�F�Vנw���{�^�. The inquiry into whether a purchaser is relying on the efforts of others focuses on two key issues: Although no one of the following characteristics is necessarily determinative, the stronger their presence, the more likely it is that a purchaser of a digital asset is relying on the “efforts of others”: In evaluating whether a digital asset previously sold as a security should be reevaluated at the time of later offers or sales, there would be additional considerations as they relate to the “efforts of others,” including but not limited to: An evaluation of the digital asset should also consider whether there is a reasonable expectation of profits. [6] The focus of the Howey analysis is not only on the form and terms of the instrument itself (in this case, the digital asset) but also on the circumstances surrounding the digital asset and the manner in which it is offered, sold, or resold (which includes secondary market sales). For example, take the case of an online retailer with a fully-developed operating business. The framework is not intended to be an exhaustive overview of the law; rather, it is a tool to help market participants assess whether … See Turner, 474 U.S. at 482; see also The DAO Report (although DAO token holders had certain voting rights, they nonetheless reasonably relied on the managerial efforts of others). 1994) (discussing horizontal commonality as “the tying of each individual investor’s fortunes to the fortunes of the other investors by the pooling of assets, usually combined with the pro-rata distribution of profits” and two variants of vertical commonality, which focus “on the relationship between the promoter and the body of investors”). Whether a particular digital asset at the time of its offer or sale satisfies the Howey test depends on the specific facts and circumstances. 1974) (citation and quotation marks omitted). [11]. [9], Courts generally have analyzed a “common enterprise” as a distinct element of an investment contract. at 299. [10] In evaluating digital assets, we have found that a “common enterprise” typically exists. See also Tcherepnin, 389 U.S. at 336 (“in searching for the meaning and scope of the word ‘security’ in the [Acts], form should be disregarded for substance and the emphasis should be on economic reality.”)(go back), 14SEC v. Glenn W. Turner Enter., Inc., 474 F.2d 476, 482 (9th Cir. For all those market participants who were unclear as to whether or not their token constituted a security, on April 3, 2019, the SEC released its long-awaited guidance titled "Framework for 'Investment Contract' Analysis of Digital Assets"1 (the "Framework").The Framework represents the Staff's views and is not a rule, … SEC Issues Guidance on "Investment Contract" Analysis of Digital Assets. 2 At the same time, the Division of Corporation Finance issued a no-action response to an aviation company in connection with its proposed offer and sale of blockchain-based digital assets … It also identifies some of the factors to be considered in determining whether and when a digital asset may no longer be a security. 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