On June 6, U.S. SEC Chairman Jay Clayton was interviewed on CNBC about Bitcoin and cryptocurrencies. He said, in effect, that “cryptocurrencies, these are replacements for sovereign currencies, replace the dollar, the euro, the yen with bitcoin… that type of currency is not a security.”
As a securities lawyer and SEC defense counsel, I thought this was an absolutely correct statement of law, and refreshing candor from the SEC Chairman. What has concerned me over the past year or so is that I have heard a lot of chatter about Bitcoin, alt-coin assets, ICOs, cryptocurrencies, and other crypto-assets as if they are one gigantic “thing,” with indistinguishable characteristics and susceptible to a one-size-fits-all regulatory regime. I have always believed that is the wrong approach. Crypto-products defy easy and quick characterization from a regulatory perspective, and specifically from the SEC standpoint. In the interview, Chairman Clayton said the following in so many words: “Do the analysis on a case-by-case basis, or, if you don’t, you proceed at your own peril and expense.”
Some cryptocurrencies or crypto-assets will not be a security, and therefore will not be regulated as a security by the SEC. Only those cryptocurrencies and crypto-assets that involve an investment of money in a common enterprise with profits to come solely from the efforts of others will rise to the level of being a security. This is known as the Howey test, named after the U.S. Supreme Court’s 1946 ruling in SEC v. Howey Co., which concluded that offerings of interests in a citrus grove constituted a security. Under the U.S. federal securities laws, these are known as “investment contracts” and they are treated as securities. The offer and sale of these must either be registered under the Securities Act of 1933, or exempt from registration under a specific exemption, and they are subject to the anti-fraud provisions of the federal securities laws. Parties that engage in the purchase, sale, and offer of these types of assets must also look closely at whether they need to register as a broker-dealer or exchange under the Securities Exchange Act of 1934. The point is, the initial determination of whether a particular crypto-asset is a “security” will have a significant impact on regulatory exposure down the road.
Chairman Clayton’s statements about cryptocurrencies that act as replacements for sovereign currencies is one example of a crypto-asset that does not constitute a security. Also, crypto coins that have some utility beyond merely being held for investment or sale in the secondary market, such as crypto-assets issued by retailers or businesses for the purchase of goods or services, could arguably also fall outside of the definition of a security. However, Chairman Clayton also stood incredibly firm on the proposition that if a crypto-asset is offered as a part of a common enterprise and has value largely derived from the value of that underlying enterprise, which is created through efforts of others, it is a security. The SEC seems very certain in its position.
Ask yourself: Where does a particular crypto-asset get its value? Can I use it to buy things or services, or does it get its value primarily from an underlying business’ fortunes? The latter is far more likely to be a security than the former. Of course, the devil always lies in the detail and in the middle scenarios. Chairman Clayton also extended this coverage to an emerging area—public offerings of securities in an existing company (perhaps even publicly traded) which are normally done through the issuance of stock, but now are also being done through the issuance of coins. At least one company to date has publicly offered securities through a SEC-registered offering, in part through coins.
In response to questions about specific crypto-asset products, and whether they constitute a security, Chairman Clayton demurred, stating that he would not comment on any particular asset. He took a similar approach when asked about crypto-currency ETFs, saying that the SEC’s Division of Investment Management has issued clear guidance on the approval of ETFs, which will apply to crypto-currency ETFs, and that one criteria is reliability of pricing. Chairman Clayton also, in a somewhat oblique fashion, appeared to invite companies interested in a potential offering of crypto-securities to speak with the SEC about any questions they may have. This seems to coincide with the creation, yesterday, of a brand new position at the SEC: Associate Director of the Division of Corporation Finance and Senior Advisor for Digital Assets and Innovation. Valerie Szczepanik will be assuming that role.