Since the arrival of Bitcoin in 2009, the world’s first decentralized cryptocurrency, securities attorneys, officials at the U.S. Securities and Exchange Commission, and others have wrestled with the question of whether any particular encrypted cash system should technically qualify as currency or a security. Recent SEC enforcement actions and a ruling by a federal judge in the Eastern District of New York have continued to fuel that discussion.
“That’s what this is all about,” said Rikard Lundberg, shareholder at Brownstein Hyatt Farber Schreck. “There’s been a fair amount of pronouncement by the Securities and Exchange Commission since July of 2017 that anyone involved in this space will need to evaluate whether their token is a security.”
On Sept. 11, the SEC settled charges in a case against the company Crypto Asset Management LP, which had allegedly violated securities law by making a public offering of a security without first registering it. Companies dealing in securities (as opposed to with a currency) are subject to certain federal regulations, including registering the security in the applicable states or pursuing an exemption from that obligation.
Those types of securities disclosures are required pursuant to the Securities Act of 1933. The case against Crypto Asset Management is the first time the SEC pursued a violation against an investment company for failing to register a security as the act requires. On the same day, though, the SEC also settled a case against TokenLot LLC, which bills itself as an ICO, or initial coin offering, superstore for “over 200 digital tokens.” In the settled case, TokenLot had not registered the securities it sold. As part of the agreement, the company agreed to relinquish $471,000 and pay $7,929 in interest.
Taken together, the settlements were viewed by some as a warning sign sent by the SEC to those dealing with cryptocurrencies. “If you just read these enforcements,” Lundberg said, “you get the sense that all this stuff is securities.”
The market that started with Bitcoin several years ago has since grown considerably; there are now more than 1,500 cryptocurrencies.
The test used to define what constitutes a security, or an “investment contract,” was developed in a 1946 decision by the U.S Supreme Court in the case SEC v. Howey and is now referred to as the Howey test. The test has four components: Is it an investment of money; is there an expectation of profits from the investment; is the investment of money in a common enterprise; and will a promoter or third-party make any profit from the exchange. That, Lundberg said, will continue to be the test.