To SEC Chair Jay Clayton, so far, it sure appears that way. Yesterday, Clayton issued a statement on cryptocurrencies and initial coin offerings, which warns that, of the ICOs that Clayton has seen promoted so far, “[b]y and large, the structures…involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws. Generally speaking, these laws provide that investors deserve to know what they are investing in and the relevant risks involved.” This position is consistent with Clayton’s unscripted observation during his remarks at the 2017 PLI Securities Regulation Institute (see this PubCo post) that, other than pure cryptocurrency, he had yet to see an ICO that did not have some indicia of a securities offering. In his statement, he indicates that he has asked SEC Enforcement “to police this area vigorously.”
With regard to ICOs, Clayton cautioned that a change in form of a securities offering does not necessarily take the transaction outside of the securities laws: that is, “replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.” In past enforcement actions with respect to ICOs, he observed, the SEC has applied “longstanding securities law principles to demonstrate that a particular token constituted an investment contract and therefore was a security under our federal securities laws. Specifically, we concluded that the token offering represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”
In contrast, cryptocurrencies “purport to be items of inherent value (similar, for instance, to cash or gold) that are designed to enable purchases, sales and other financial transactions.” But, Clayton advised, form should not be elevated over substance with regard to cryptocurrencies either; “simply calling something a ‘currency’ or a currency-based product does not mean that it is not a security.”
To convey that their proposed ICOs were not securities offerings, Clayton notes, some participants have highlighted the “utility characteristics” of the tokens or coins, but, so long as they “emphasize the potential for profits based on the entrepreneurial or managerial efforts of others,” these tokens or coins “continue to contain the hallmarks of a security under U.S. law.” Gatekeepers, such as securities counsel and others, Clayton emphasized (in bold), need to fulfill their responsibilities in this regard.
To illustrate the difference between pure cryptocurrency and a security, Clayton offered the following example:
“[ICOs] can take many different forms, and the rights and interests a coin is purported to provide the holder can vary widely. A key question for all ICO market participants: ‘Is the coin or token a security?’ As securities law practitioners know well, the answer depends on the facts. For example, a token that represents a participation interest in a book-of-the-month club may not implicate our securities laws, and may well be an efficient way for the club’s operators to fund the future acquisition of books and facilitate the distribution of those books to token holders. In contrast, many token offerings appear to have gone beyond this construct and are more analogous to interests in a yet-to-be-built publishing house with the authors, books and distribution networks all to come. It is especially troubling when the promoters of these offerings emphasize the secondary market trading potential of these tokens. Prospective purchasers are being sold on the potential for tokens to increase in value—with the ability to lock in those increases by reselling the tokens on a secondary market—or to otherwise profit from the tokens based on the efforts of others. These are key hallmarks of a security and a securities offering.”
Whether any digital asset is a pure cryptocurrency will depend on the characteristics and use of that particular asset. In any event, Clayton contended, even pure cryptocurrencies are not entirely beyond the SEC’s oversight, in the same way that the SEC monitors how U.S. and foreign currencies transactions affect the securities markets, including “securities firms and other market participants that allow payments to be made in cryptocurrencies, set up structures to invest in or hold cryptocurrencies, or extend credit to customers to purchase or hold cryptocurrencies.”