Staff at the United States Securities and Exchange Commission (SEC) have published a framework to help market participants ascertain whether or not a digital asset is deemed to be an investment contract, and therefore a security. The new “Framework for ‘Investment Contract’ Analysis of Digital Assets” was published on April 3, accompanied by an official statement.
Notably, the framework is the work of two SEC Commissioners: Bill Hinman, director of the SEC’s Division of Corporation Finance and Valerie Szczepanik, Senior Advisor for Digital Assets and Innovation — colloquially known as the Commission’s “crypto czar.”
The guidance is therefore not a rule, regulation, or statement of the U.S. Commission, which has reportedly neither approved nor disapproved its content.
As the authors stress, the framework is not intended to be exhaustive nor to provide formal legal advice, but to serve as an analytical tool that will help operators of initial coin offerings (ICO) and token issuers determine whether their offering is likely to fall subject to federal securities laws. Market participants are thus urged to further consult the formal rules and regulations available on the SEC’s Strategic Hub for Innovation and Financial Technology (FinHub).
The framework focuses on determining whether a digital asset has the characteristics of one particular type of security — an investment contract — rather than covering the full gamut of possible security classifications.
In accordance with the 71-year old Howey Test, such a contract is deemed to exist where there is an investment in a common enterprise, in which investors are reasonably led to expect profits that other generate.
The authors’ framework tackles in detail all aspects of the Howey test in regard to digital assets, beginning with the investment of money and the distinct element of a common enterprise that holds for investment contracts. In regard to this latter, the authors note, “in evaluating digital assets, we have found that a ‘common enterprise’ typically exists.”
The framework devotes just over six pages to the most complex criterion — “a reasonable expectation of profits derived from the efforts of others” — noting that this is usually the “main issue in analyzing a digital asset under the Howey test.”
The authors state that a large part of the inquiry for this criterion focuses on the economic reality of the transaction itself and “what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect.”
As previously reported, multiple crypto industry figures and lawmakers have repeatedly called on the SEC to provide greater regulatory clarity for the interaction of blockchain-based tokens and securities laws.