SEC New Tools to Assess Cryptocurrencies

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.  The registration provisions require persons to disclose certain information to investors, and that information must be complete and not materially misleading.  This requirement for disclosure furthers the federal securities laws' goal of providing investors with the information necessary to make informed investment decisions.

When it comes to start up funding and initial coin offerings, the SEC rules were left ambiguously. The current legal framework applies to IPO cannot be easily apply to ICO, as they are so different than each other. As cryptocurrencies are significantly decentralized, and the underlying source information is open to any market participant, the current securities acts are not proper fits.

On April 3, 2019, the SEC attempted to provide clarity by releasing a “Framework for ‘Investment Contract’ Analysis of Digital Assets".

It attempted to provide a toolkit to to apply the Howey test to digital assets. The "Howey Test" is a test created by the Supreme Court for determining whether certain transactions qualify as "investment contracts." If so, then under the Securities Act of 1933 and the Securities Exchange Act of 1934, those transactions are considered securities and therefore subject to certain disclosure and registration requirements.

Under the Howey Test, a transaction is an investment contract if:

1. It is an investment of money

2. There is an expectation of profits from the investment

3. The investment of money is in a common enterprise

4. Any profit comes from the efforts of a promoter or third party

The "Framework" provided requirements to apply the Howey Test, which listed factors to help determine if an investor has a reasonable expectation of profits derived from the efforts of others. The SEC also issued an no-action letter regarding tokens issued by TurnKey Jet (TKJ). The application of Howey Test and no-action letter indicated that SEC is open to exclude some cryptocurrencies from the security registration requirements. Although, rooms are left for SEC and judicial intervention to move forward for the clarity work.