The SEC’s “Framework for ‘Investment Contract’ Analysis of Digital Assets” aims to help answer the key question hovering over ICO project of when is a digital token a security? While early reviews are mostly positive, some crypto lawyers say more needs to be done.
SEC action on crypto has taken a number of forms — with guidance by enforcement, guidance through humour, lectures on ethics and AMAs at crypto conferences. Although it is arguable that all those efforts have made it quite clear what the SEC’s expectations are regarding ICOs, it has nonetheless been met with a chorus of requests for ‘guidance’ – to which it has finally responded with a new 13 page framework for crypto tokens.
Though the framework is not backed by the force of law, it gives clear direction to projects wanting to avoid getting tangled up in regulations, and has roused a range of responses from crypto lawyers. Commentators have both praised the SEC for casting more light on the issue, and dismissed the guidance as an attempt to push ICOs back into the box from which they sprung.
The lawyers respond
Echoing speeches and former guidance, the framework makes suggestions for how the Howey Test might be applied to tokens — forming what crypto attorney and Twitter commentator Jake Chervinsky describes as a “checklist of characteristics” that provide “solid ground to analyze any given ICO” against securities law.
These characteristics include “reasonable expectation of profits”, “reliance on the efforts of others,” and “a correlation between a token’s purchase price and its market price”. Tokens which might appreciate from “the operation, promotion, improvement, or other positive developments in the network” are unlikely to pass muster, especially if there is a “secondary trading market that enables digital asset holders to resell their digital assets and realize gains”.
While these characteristics might sound like the basic ingredients of an ICO, the SEC have celebrated publication of the framework by issuing the first ever no-action letter to a token sale. But the token of aircraft charter startup Turnkey Jet, which received the letter, is arguably more akin to a supermarket coupon than your typical ICO — and will now be subject to tough restrictions to ensure it doesn’t start to resemble an investment contract.
This alone has been enough to please many lawyers, with Chervinsky conceding he is “(mostly) happy” with the framework, and fintech-focused lawyer Richard Levin saying it should “have a positive impact on the development of digital assets that are compliant with U.S. securities laws.”
But beyond a fleeting satisfaction at finally receiving the guidance, which has been six months in the making, lawyers have fired criticism at the SEC for failing to delve into the deeper questions of decentralization: “Remember all those arguments about the term "sufficiently decentralized"? Tweeted Chervinsky “It doesn’t show up even once in the SEC’s DLT Framework. In fact, the word "decentralized" only appears one time in the entire document. A good reminder not to get too excited about non-binding guidance.”
Others have been even more scathing. An anonymous senior lawyer speaking to Fortune denounced the framework as an “overt declaration of war on cryptocurrencies”, claiming that it fails to acknowledge how crypto tokens are distinct from other assets.
Levin takes a more positive perspective, suggesting that the guidance might be useful for its intended purpose — helping fintech firms to develop new products in a way that is consistent with U.S. securities laws, and in the process separating the wheat from the chaff by driving corrupt companies out: “The guidance should have a positive impact on the development of digital assets that are compliant with U.S. securities laws” said Levin. “Some fintech firms may elect to leave the United States. However, as the largest economy in the world, and as the leading global financial market with a meaningful interest in digital assets, I believe most fintech firms will not leave.”
Securities lawyer Albert Lung, who specializes in emerging technology, takes a stronger view — suggesting that the new guidelines will have a “huge chilling effect”, turning American crypto entrepreneurs into regulatory refugees seeking more permissive jurisdictions like Malta and Singapore for their token sales.
One thing all commentators seem to be able to agree on, is that despite the guidance, there is no one-size fits all solution to cover the endless different forms that token offerings can take. So the only conclusive way to establish compliance, is for token projects to engage directly with the SEC through its newly established FinHub. “While the guidance is helpful,” Levin says, “everyone needs to remember that as is often noted by the SEC, the analysis of whether an instrument is a security depends on the “specific facts and circumstances.”