In mid-December, 2017, when the SEC Chair, Jay Clayton, warned that the SEC would be specifically scrutinizing cryptocurrencies and initial coin offerings (ICOs) under applicable securities laws that apply to the offer and sale of securities, Chair Clayton was simply restating the long-established case law and practice used by the SEC and other state and federal regulators.
Since 1946 with the Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293, a security has been broadly defined to include any “investment of money in a common enterprise with profits to come solely from the efforts of others.” How broadly this has been applied over the years includes the SEC taking action against a company that promised a “road to riches” as the first company in “the world to learn the secrets of the beaver.” See Continental Marketing Corporation v. SEC, 387 F.2d 466. Whether it be Bitcoins or Beavers, the Supreme Court has made it clear that securities laws apply to “virtually any instrument that might be sold as an investment.” See SEC v. Edwards, 540 U.S. 389.
Securities are more than just equity in companies or debt instruments. A broader definition also includes “investment contracts.” Let us briefly revisit the first major case in this area, SEC v. W.J. Howey Co., 328 U.S. 293. In this case, a company was selling portions of orange groves to investors. As part of the sale of land, the company included a contract for the management of the orange groves. This meant that if you had bought one of these packages, you would get a portion of the orange groves and someone else would take care of it, then you would earn profits on the whole deal based on your percentage interest in the groves. The sale of these contracts turned out to be a security and thus subject to the securities laws. The court defined what could be a security (now known as the “Howey Test”) as that which includes “an investment of money in a common enterprise with profits to come solely from the efforts of others.”
The Howey Test, when applied to activities such as investing in cryptocurrency or ICOs, appears to fall within what is deemed a security. The investor buying the asset or contract never takes possession of the item and relies on the efforts of others for the investment to grow in value. In terms of the definition of “investment contract,” the purchaser has made an investment for value in a common enterprise (the mining assets or ICO) with profits to come solely from the efforts of others (the miner or company engaged in the ICO). It should be noted that where these interests are represented by ownership interests in an entity (LLC, Corp. or other entity) and such interests are issued for value, the analysis need not dwell on whether or not an “investment contract” exists as the equity issued is clearly a security.
As the new “greatest thing” since beavers, cryptocurrencies and ICOs are simply the newest investment opportunity subject to securities laws. Just because they represent a thing of value (like gold or currencies), does not release them from the significant securities compliance obligations and potential liabilities that follow.
If you are offering cryptocurrencies in any manner, you should discuss your situation with a securities attorney. Failure to comply with applicable state and federal securities laws can result in significant personal liability (civil and criminal). On the flip side, if you have lost money in an investment in cryptocurrencies, you may be entitled to significant protections and damages pursuant to applicable state and federal securities laws.
Michael Best has an integrated team that works with clients in the cryptocurrency, ICO, and blockchain space. Members of our team and what we do can be found here –
We assist in securities, investment, Bitcoin and other cryptocurrencies, intellectual property, privacy and security, blockchain implementation, and other matters in this space.