The future (and not present) functionality of the network or digital asset, and the prospect that an AP will deliver that functionality. (go back), 7Issuers of digital assets, like all issuers, must provide full and fair disclosure of material information consistent with the requirements of the federal securities laws. There are essential tasks or responsibilities performed and expected to be performed by an AP, rather than an unaffiliated, dispersed community of network users (commonly known as a “decentralized” network). The AP is able to benefit from its efforts as a result of holding the same class of digital assets as those being distributed to the public. 1This framework represents the views of the Strategic Hub for Innovation and Financial Technology (“FinHub,” the “Staff,” or “we”) of the Securities and Exchange Commission (the “Commission”). 108 0 obj
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If the AP facilitates the creation of a secondary market, transfers of the digital asset may only be made by and among users of the platform. �
�\_�g�9��Ǒ@E�$Ѝ ʡ��gL� .t�!J)��l���O�I��:;×�j�TImOc Rather, the guide helps investors and companies determine the classification of a particular token. The report is titled Framework for “Investment Contract” Analysis of Digital Assets, and is prefaced by the following Public Statement framing it. There is little apparent correlation between the purchase/offering price of the digital asset and the market price of the particular goods or services that can be acquired in exchange for the digital asset. The trading volume for the digital asset corresponds to the level of demand for the good or service for which it may be exchanged or redeemed. (go back), 15In this guidance, we are using the term “network” broadly to encompass the various elements that comprise a digital asset’s network, enterprise, platform, or application. It is not an exhaustive treatment of the legal and regulatory issues relevant to conducting an analysis of whether a product is a security, including an investment contract analysis with respect to digital assets generally. If it is characterized as a virtual currency, the digital asset actually operates as a store of value that can be saved, retrieved, and exchanged for something of value at a later time. Does the purchaser reasonably expect to rely on the efforts of an AP? endstream
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This requirement for disclosure furthers the federal securities laws’ goal of providing investors with the information necessary to make informed investment decisions. The SEC published a Framework for Investment Contract Analysis of Digital Assets on April 3, 2019. The digital asset is marketed in terms that indicate it is an investment or that the solicited holders are investors. As part of a continuing effort to assist those seeking to comply with the U.S. federal securities laws, FinHub is publishing a framework for analyzing whether a digital asset is offered and sold as an investment contract, and, therefore, is a security. . 2. [3] The term “security” includes an “investment contract,” as well as other instruments such as stocks, bonds, and transferable shares. When a promoter, sponsor, or other third party (or affiliated group of third parties) (each, an “Active Participant” or “AP”) provides essential managerial efforts that affect the success of the enterprise, and investors reasonably expect to derive profit from those efforts, then this prong of the test is met. The new framework provides an in-depth description of how the SEC uses a measure called the Howey Test to determine whether a given asset qualifies as a type of security called an investment contract. [18] Price appreciation resulting solely from external market forces (such as general inflationary trends or the economy) impacting the supply and demand for an underlying asset generally is not considered “profit” under the Howey test. Whether a particular digital asset at the time of its offer or sale satisfies the Howey test depends on the specific facts and circumstances. The registration provisions require persons to disclose certain information to investors, and that information must be complete and not materially misleading. Under these facts, the digital asset would not be an investment contract. Making other managerial judgements or decisions that will directly or indirectly impact the success of the network or the value of the digital asset generally. SEC Framework for “Investment Contract” Analysis of Digital Assets On April 3, 2019, the SEC’s FinHub released a “Framework for ‘Investment Contract’ Analysis of Digital Assets.”1 The Framework is the SEC staff’s most detailed pronouncement to date on when the staff would consider Initial Coin Offerings This also can be the case where the digital asset gives the holder rights to dividends or distributions. (go back), 9The lack of monetary consideration for digital assets, such as those distributed via a so-called “bounty program” does not mean that the investment of money prong is not satisfied. The potential profitability of the operations of the network, or the potential appreciation in the value of the digital asset, is emphasized in marketing or other promotional materials. See TSC Industries v. Northway, 426 U.S. 438, 449 (1976) (a fact is material “if there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision or if it “would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” to the shareholder). The value of the digital asset has shown a direct and stable correlation to the value of the good or service for which it may be exchanged or redeemed. Among the information that must be disclosed is information relating to the essential managerial efforts that affect the success of the enterprise. Therefore, issuers and other persons and entities engaged in the marketing, offer, sale, resale, or distribution of any digital asset will need to analyze the relevant transactions to determine if the federal securities laws apply. Purchasers would reasonably expect the AP to undertake efforts to promote its own interests and enhance the value of the network or digital asset, such as where: The AP has the ability to realize capital appreciation from the value of the digital asset. The digital asset gives the holder rights to share in the enterprise’s income or profits or to realize gain from capital appreciation of the digital asset. It is not an exhaustive treatment of the legal and regulatory issues relevant to conducting an analysis of whether a product is a security, including an investment contract analysis with respect to digital assets generally. [8] Absent the disclosures required by law about those efforts and the progress and prospects of the enterprise, significant informational asymmetries may exist between the management and promoters of the enterprise on the one hand, and investors and prospective investors on the other hand. SEC Issues Guidance on "Investment Contract" Analysis of Digital Assets. The digital asset is transferable or traded on or through a secondary market or platform, or is expected to be in the future. (go back), 21See Forman, 421 U.S. at 852-53 (where a purchaser is not “’attracted solely by the prospects of a return’ on his investment . With respect to a digital asset referred to as a virtual currency, it can immediately be used to make payments in a wide variety of contexts, or acts as a substitute for real (or fiat) currency. Howey Co. at 299. For example, the digital asset can only be used on the network and generally can be held or transferred only in amounts that correspond to a purchaser’s expected use. Also, no one factor is necessarily dispositive as to whether or not an investment contract exists. 488, 496 n.13 (Apr. [21]. Introduction If you are considering an Initial Coin Offering, sometimes referred to as an “ICO,” or otherwise engaging in the offer, sale, or distribution of a digital asset,2 you need to consider whether the U.S. federal securities laws apply. To the extent these facts are present, the compensated individuals can be expected to take steps to build the value of the digital asset. endstream
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(FinHub) attempted to provide some clarity by issuing a “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which provides a toolkit to apply the Howey test to digital assets… An AP has a lead or central role in the direction of the ongoing development of the network or the digital asset. In these instances, purchasers would reasonably expect the AP to undertake efforts to promote its own interests and enhance the value of the network or digital asset. (go back), 4This framework is intended to be instructive and is based on the Staff’s experiences to date and relevant law and legal precedent. The Framework sets out a number of additional factors to consider when evaluating whether a digital asset previously sold as a security should be re … 1985). As noted above, under the Howey test, an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. The AP continues to expend funds from proceeds or operations to enhance the functionality or value of the network or digital asset. The Framework Consistent with the SEC’s prior guidance, the Framework outlines the applicable standard for analyzing digital assets under the securities laws by applying the “investment contract” test articulated in S.E.C. In a so-called “airdrop,” a digital asset is distributed to holders of another digital asset, typically to promote its circulation. No. 1 Framework for “Investment Contract” Analysis of Digital Assets1 I. the securities laws do not apply.”). hޤUmO�0�+�� �$q Uj��M�U$��ⵑҤJ����|vi �-
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Determining who will receive additional digital assets and under what conditions. Although no one of the following characteristics is necessarily determinative, the stronger their presence, the more likely it is that a purch… Both documents are pre-requisite reads in order to get the full context of my remarks below. Keep up with the latest legal and industry insights, news, and events from MoFo Sign Up. (go back), 10In order to satisfy the “common enterprise” aspect of the Howey test, federal courts require that there be either “horizontal commonality” or “vertical commonality.” See Revak v. SEC Realty Corp., 18 F.3d. The AP has raised an amount of funds in excess of what may be needed to establish a functional network or digital asset. See, e.g., Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (Exchange Act Rel. C. Reasonable Expectation of Profits Derived from the Efforts of Others Upon receipt of the digital asset, consumers immediately are able to purchase products on the network using the digital asset. �P���Z�Sj���9�{����������B���%��m���ֈų?������Y��m���`�������%�^���0W��}s���e��gᾡ9
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b-��,w8M3�f�e�3�~�������,�`Բ0zY�4x��d�w�o�sv�FnQ;o���mV��\a����CD�ꁺz`�z��!��ت�Q���VoT������t�>�ٻ'��m����j����Q�F�Vנw���{�^�. [5] The so-called “Howey test” applies to any contract, scheme, or transaction, regardless of whether it has any of the characteristics of typical securities. Holders of the digital asset are immediately able to use it for its intended functionality on the network, particularly where there are built-in incentives to encourage such use. [4] The new FinHub framework delivers on that announcement, providing a useful analytical tool for … An AP is responsible for the development, improvement (or enhancement), operation, or promotion of the network. Are those efforts "the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise,"as opposed to efforts that are more ministerial in nature? �%Փ4_`�ժ�gL{�s��( Relevant factors may include: There is a correlation between the purchase price of the digital asset and a market price of the particular good or service for which it may be redeemed or exchanged. 88 0 obj
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In this guidance, we provide a framework for analyzing whether a digital asset has the characteristics of one particular type of security—an “investment contract.” [4] Both the Commission and the federal courts frequently use the “investment contract” analysis to determine whether unique or novel instruments or arrangements, such as digital assets, are securities subject to the federal securities laws. The framework is not intended to be an exhaustive overview of the law; rather, it is a tool to help market participants assess whether … (go back), Posted by Tami Groswald Ozery, Harvard Law School Program on Corporate Governance, on, Harvard Law School Forum on Corporate Governance, on Framework for “Investment Contract” Analysis of Digital Assets. Howey Co., 328 U.S. 293 (1946), to determine whether a digital asset that is offered and sold is an investment contract … On April 3, 2019, the SEC announced the framework it would use to determine whether a digital asset would be considered an “investment contract” in light of the Supreme Court’s ruling in SEC v. W.J. (go back), 11Based on our experiences to date, investments in digital assets have constituted investments in a common enterprise because the fortunes of digital asset purchasers have been linked to each other or to the success of the promoter’s efforts. 1974) (citation and quotation marks omitted). When it Comes to Analyzing Utility Tokens, the SEC Staff’s “Framework for ‘Investment Contract’ Analysis of Digital Assets” May Be the Emperor Without Clothes (Or, Sometimes an Orange Is Just an Orange) (Part I) Oct 28, 2019 On December 11, 2017, SEC Chairman Jay Clayton noted that whether a digital asset is a security "will depend on the characteristics and use of that particular asset." The digital assets’ creation and structure is designed and implemented to meet the needs of its users, rather than to feed speculation as to its value or development of its network. The framework was cobbled together by SEC Commissioners Valerie Szczepanik, Senior Advisor for Digital Assets and Innovation aka “crypto czar” and Bill Hinman, director of the SEC’s Division of Corporation Finance. (go back), 5SEC v. W.J. The inquiry into whether a purchaser is relying on the efforts of others focuses on two key issues: 1. Although no one of the following characteristics of use or consumption is necessarily determinative, the stronger their presence, the less likely the Howey test is met: Digital assets with these types of use or consumption characteristics are less likely to be investment contracts. The AP owns or controls ownership of intellectual property rights of the network or digital asset, directly or indirectly. The intended use of the proceeds from the sale of the digital asset is to develop the network or digital asset. Amid a flurry of calls for more clarity within the cryptospace, two leading SEC crypto experts released a documen t this week called the Framework for Investment Contract Analysis of Digital Assets.
Whether holders are then able to use the digital asset for its intended functionality, such as to acquire goods and services on or through the network or platform. Whether the network on which the digital asset is to function operates in such a manner that purchasers would no longer reasonably expect an AP to carry out essential managerial or entrepreneurial efforts. The federal securities laws require all offers and sales of securities, including those involving a digital asset, to either be registered under its provisions or to qualify for an exemption from registration. For example, take the case of an online retailer with a fully-developed operating business. ), cert. With respect to a digital asset that represents rights to a good or service, it currently can be redeemed within a developed network or platform to acquire or otherwise use those goods or services. (go back), 19Situations where the digital asset is exchangeable or redeemable solely for goods or services within the network or on a platform, and may not otherwise be transferred or sold, may more likely be a payment for a good or service in which the purchaser is motivated to use or consume the digital asset. While this framework did not rise to the level of an official statement by the SEC, it generated a lot of excitement in the industry. On April 3, 2019, the SEC released Staff Guidance titled “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which applies the factors set forth in SEC v. W.J. The more the following characteristics are present, the more likely it is that there is a reasonable expectation of profit: In evaluating whether a digital asset previously sold as a security should be reevaluated at the time of later offers or sales, there would be additional considerations as they relate to the “reasonable expectation of profits,” including but not limited to: When assessing whether there is a reasonable expectation of profit derived from the efforts of others, federal courts look to the economic reality of the transaction. The retailer continues to market its products to its existing customer base, advertises its digital asset payment method as part of those efforts, and may “reward” customers with digital assets based on product purchases. The digital asset is available in increments that correlate with a consumptive intent versus an investment or speculative purpose. [20] In doing so, the courts also have considered whether the instrument is offered and sold for use or consumption by purchasers. �t;�IY(�Kf��Nm�f}ks����Y�N�W�"���/&8���a8����?i^Km� ��Q�7�A�0����W4���q3wT/d���(>O7W2[�� ��
�x���y��>���� h�A��0�`F'�:��}I����L�E��:-�ڱ,�E6Op�ҵ����������L�����&1a���Z���in\wj��~Si�-F�2���X��OD=n�XH��6���V�� �i-!f��bQ>f��eŨ���������*���:�&A��iB}��� "As part of a continuing effort to assist those seeking to comply with the U.S. federal securities laws, FinHub is publishing a framework for analyzing whether a digital asset is offered and sold as an investment contract, and, therefore, is a security. Framework for Investment Contract Analysis of Digital Asset Transactions. %%EOF
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framework for investment contract analysis of digital assets 1
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