The Securities and Exchange Commission’s Strategic Hub for Innovation and Financial Technology, known as the FinHub, published a digital assets framework Wednesday to help entities involved in the space analyze whether a digital asset is offered and sold as an investment contract, and, therefore, is a security.
Bill Hinman, director of the Division of Corporation Finance, along with Valerie Szczepanik, senior advisor for Digital Assets and Innovation, stated that depending on the nature of the digital asset, “including what rights it purports to convey and how it is offered and sold, it may fall within the definition of a security under the U.S. federal securities laws.”
The framework — which represents staff views and is not rule, regulation or statement of the commission — is part of the agency’s continuing efforts to aid compliance regarding digital assets, the two state.
The “Framework for ‘Investment Contract’ Analysis of Digital Assets,” Hinman and Szczepanik state, “is not intended to be an exhaustive overview of the law, but rather, an analytical tool to help market participants assess whether the federal securities laws apply to the offer, sale or resale of a particular digital asset.”
Albert Lung, a lawyer with Morgan, Lewis & Bockius LLP, told ThinkAdvisor in a Wednesday email message that the FinHub framework, in general, “is a positive development because it provides some clarity in a very uncertain if not unruly regulatory environment.”
The framework “would provide companies, including many of our clients, with much needed guidance on how to design, operate and if appropriate issue and sell digital assets and tokens,” Lung added.
Hinman and Szczepanik warn that as “financial technologies, methods of capital formation and market structures continue to evolve, market participants should be aware that they may be conducting activities that fall within our jurisdiction.”
For example: “Market participants may engage in activities that require registration of transactions and persons or entities involved in those transactions,” they state.
Even if no registration is required, activities involving digital assets that are securities may still be subject to the commission’s regulation and oversight.
The information contained in the framework may apply to entities conducting the following activities related to digital assets:
- offering, selling or distributing
- marketing or promoting
- buying, selling or trading
- facilitating exchanges
- holding or storing
- offering financial services such as management or advice
- other professional services.
Ricardo Davidovich, a partner in the Investment Management and Private Equity Practice Groups in the New York office of Haynes and Boone, adds that the framework is “targeted for the public and for those looking to issue an ICO.”
The proceedings against ICOs, “where the SEC has alleged that the offering was an unregistered security, has hinged on the SEC’s finding or allegation that there was an investment contract, which is a specific type of security,” Davidovich said in an email message.
“The criteria for determining if something is an investment contract were first set forth by the Supreme Court in SEC v. W. J. Howey Co., commonly referred to as Howey, and refined by some cases which followed. Interestingly, Howey involved the sale of orange groves and was decided in 1946: the same principles are now being applied to determine if something as modern as a crypto assets are securities,” he continued. “The resulting case law is that something is an investment contract when there is the investment of money in a common enterprise with the reasonable expectation of profits derived from the efforts of others.”
The framework “discusses the Howey elements and gives examples of the last one, which is the hardest to understand/deal with. The case law is more complicated than the release implies — there are many factors to consider when determining whether there is an expectation of profits and whether such expectation is to be derived from the efforts of others.”
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