Compare apples to orange [Groves]: How the SEC defines digital assets as securities | Ulmer & Berne SARL

In any classic securities regulation textbook, you will likely find a chapter called “Definition of a Security”. Besides your typical bonds and stocks, which are easily identifiable as securities, the most infamous question (and certainly on the final law school exam) is: what is a contract of law? investment and under what circumstances is it considered a security? The quintessential catch-all, the term “investment contract” has been interpreted broadly by the courts to apply to a wide range of fundraising programs that have proven to be securities (even as far as interest in whiskey warehouse receipts).

This case progeny comes from the historical case of SEC c. WJ Howey Co. in which the Supreme Court established the “Howey test” for an investment contract. For those of you who are unfamiliar with the case or need a refresher, please Howey, a hotelier sold an interest in orange groves as an investment plan, combining both a real estate contract for the sale of plots of land and a service contract for cultivating orange trees. The Court, focusing on the economic reality of the transaction, ruled that the circumstances surrounding the sale of the interests in the orange grove constituted an investment contract and therefore a security. To clarify the Court’s conclusion, it is important to underline the following distinction: the underlying asset (the orange grove) himself was not seen as a security, but rather the way the expanses of orange groves have been sold who made them an investment contract. Naturally, you might be wondering what exactly does orange groves have to do with digital assets? Turns out, the SEC thinks they have a lot more in common than you might think.

Cryptocurrencies have been buzzing about lately, but despite the growth of the Decentralized Finance (DeFi) movement, U.S. laws and regulations have stagnated and haven’t kept up with the crypto craze. Now, with the widespread acceptance of cryptocurrencies, federal agencies like the SEC are also under increasing pressure to find a way to regulate them under existing laws. This is where the Howey the test is coming.

Without new legislation to rely on, the SEC has determined that a digital asset (such as a cryptocurrency) can be considered an investment contract and therefore a security under the Howey framework. As SEC Commissioner Hester Pierce (aka “Crypto Mom”) explained, “When we think of a crypto-asset as a security, we say it’s sold under an investment contract. . This does not mean that the asset itself has to be a security. It does mean that it was being sold as collateral. Aside from Pierce’s remarks, SEC Chairman Gary Gensler recently admitted that cryptocurrencies are like the “Wild West” and continue to express its desire for more congressional regulation on the regulation of digital assets.

At the same time, however, Gensler expressed his opinion that there is no problem with how cryptocurrencies are currently treated under securities laws, concluding that “certain rules related to crypto assets are well established “. Referring again to Howey test, he also noted that “the test to determine whether a crypto asset is security is clear.” Yet it is actually the lack of regulatory clarity that has kept the cryptocurrency community in limbo on how to act and at the mercy of the scattered method of SEC enforcement regulation. As a testament to this, the SEC has now brought several digital asset cases under the Howey executive, alleging that the digital assets at issue were investment contracts and therefore securities.

In a recent case (SEC vs. Ripple) Being dubbed the “cryptocurrency lawsuit of the century,” the SEC brought a lawsuit against Ripple Labs and its founders for their unregistered offering of the XRP digital token in alleged violation of securities laws. The SEC alleged that XRP is an investment contract because of its centralized nature and the way it was offered, sold and promoted. In order to preserve the sacredness of the Howey test and its application to digital asset cases, the SEC did not allege that XRP (as in the digital token) was itself a security, but rather, it was the circumstances surrounding the XRP offering that made it so. do a.

Still, the SEC felt the need to further justify its position that XRP is an investment contract by also explaining why “XRP is not a currency”. That leaves us with a remaining question: if XRP (as in the digital token itself) isn’t a security, but it’s not a virtual currency either, then what exactly is it. ? According to the SEC, the answer is simple: it is “software code”. Respectfully, I disagree with the SEC here. The essence of a digital token cannot be diluted to have such a rudimentary meaning. By applying this kind of logic to the Howey case would be the equivalent of reducing the meaning of the orange grove to an orange seed. The XRP digital token represents something beyond software code; it represents a virtual currency. So whether the SEC wants to admit it or not, the Howey The analysis of the orange grove does not apply as precisely to the facts and circumstances surrounding XRP and its offering.

While the Ripple case guarantees to be an interesting outcome for the DeFi movement, the SEC does not intend to stop there. The SEC has put a “spotlight” on Initial Coin Offerings (“ICOs”) and continues to bring more and more cases of unregistered digital asset offerings and their promoters (celebrities not excluded), as against the star of “Above the Law” Steven Seagal. While new legislation such as the Securities Clarity Act holds promise, as the name rightly suggests, for more clarity in this area, in the meantime, the SEC will continue to regulate the nascent cryptocurrency industry by under a 75-year-old case law. Hopefully we will soon see formal cryptocurrency regulations in place so that the SEC can start looking at digital asset cases using apple-to-apple analysis rather than just doing them. compare to orange groves.