Sustained and growing interest in digital asset trading has prompted the United States Securities and Exchange Commission (SEC or “Commission”), led by its chairman (and former MIT blockchain professor) Gary Gensler, to adopt an aggressive approach to asset class regulation. . While the SEC and other regulators have offered advice and engaged in some investigative and enforcement activities, the regulation of digital assets, which have a wide range of properties and characteristics, has created legal uncertainty. and considerable regulation in space.
A critical unresolved regulatory issue is determining when a digital asset is a “security”, which triggers a host of regulatory and compliance obligations for entities and individuals involved in buying or selling the instrument. Other federal regulators, such as the Commodity Futures Trading Commission (CFTC), are seeking to increase their jurisdictional oversight. As legislation brewing in Congress seeks to address these types of issues, including the bipartisan Lummis-Gillibrand Responsible Financial Innovation Act (the “Lummis-Gillibrand Act”), the SEC continues to report that the most digital assets are “securities” and therefore he has extensive digital asset jurisdiction.
It is in this context that the Commission recently tabled
SEC c. Wow, and. Al. (2022), an insider trading case brought in Washington state federal court against a former Coinbase executive and others. The crux of the action is whether the former official unlawfully informed others in advance of digital assets that were to be listed on the Coinbase platform before the listing was publicly announced. The action is significant because it is based on the theory that the digital assets in question are in fact securities and because the complaint contains a reasonably thorough analysis of why the SEC believes they are.
Regulate cryptocurrencies before Wow
The SEC has previously provided guidance regarding digital assets in various speeches,1 reports,2 and letters of no action.3 But these guidelines have not conclusively resolved the question of the threshold of what assets are securities and have been characterized as more confusing by many industry players and even, on occasion, by a commissioner. of the SEC.4
In the Wow complaint, the SEC analyzed the issue of securities law as it generally has,5 applying the reasoning set out in a 1946 Supreme Court, SEC vs. WJ Howey Co., 328 US 293 (1946), concerning parcels of land in a Florida orange grove. The Howey test asks whether there has been an investment of money in a joint venture with the expectation of profit to be derived from the efforts of others. In 2019, the SEC published a white paper establishing a framework for the application
Howey to digital assets.6 In it, the SEC stated that “the primary problem with analyzing a digital asset under the
Howey test is whether a buyer has a reasonable expectation of profit (or other financial return) from the efforts of others.”seven
Pay attention to Wow
In Wowthe SEC continues its trend of focusing on
Howey test, but in particular carries out an independent analysis of nine different digital assets. In this regard, Wowrepresents a rare insight into the SEC’s approach. The Commission focused most of its position on the assertion that investors relied on the efforts of executives and corporate executives to increase their value. For example, RLY, an SEC token and security, was created by Rally Network, Inc. (“Rally”). For example, the SEC pointed to Rally’s promotion of the availability of RLY in secondary markets, the use of transaction revenue from RLY tokens to “cover operating costs as well as the hiring and onboarding of new team members and experts”, and how the company’s leaders were actively engaged. in building token value by holding 30% of the outstanding token amounts.8 The Commission further pointed to similar facts in the management and distribution of the other eight digital assets.
The action sparked controversy, including within the regulatory community. For example, the SEC’s main regulatory “competitor” in this area, the CFTC, expressed concern in a statement on SEC vs. Wahi, calling the action a “striking example of regulation by enforcement”. In this vein, many commentators argue that the Commission has failed to inform the stock market adequately, lacks competence, may stifle an innovative market, or be unable to consistently apply its rules and regulations to assets. digital. Commissioner Gensler was indifferent to such comments, stating that he “just has to call[s] it is “the application”.
The timing of the SEC’s complaint is particularly controversial because Congress is currently considering several legislative proposals that would strip the Commission of jurisdiction over certain types of digital assets. For example, the Lummis-Gillibrand Act seeks to distinguish between digital assets as securities and commodities granting more jurisdiction to the CFTC. While passage of this bill in its current form may be unlikely, it shows that elected officials are beginning to think seriously about regulatory “turf wars” and related market uncertainty.
The Wow complaint, while providing an overview of the SEC’s application of the Howey testing particular digital assets, has been criticized as “regulation by enforcement”. Legislatures and regulators continue to wrestle with fundamental issues regarding the regulation of digital assets, and the market is looking for regulatory clarity. Market participants should assume that, unless it is dispossessed of jurisdiction, the SEC will continue to ramp up its enforcement activities in this space, taking a broad view of what constitutes “security” under of American law.
Winston & Strawn is following these developments closely. We will provide our clients and friends of the firm with more information on this subject as it becomes available.
2. Investigative report pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (https://www.sec.gov/litigation/investreport/34-81207.pdf) (as of July 25, 2017).
See Subject: Pocketful of Quarters, Inc., Securities and Commission Exchange (dated July 25, 2019) (https://www.sec.gov/corpfin/pocketful-quarters-inc-072519-2a1);
also lookIncoming Letter re: Pocketful of Quarters, Inc., Pocketful of Quarters, Inc. (dated July 25, 2019) (https://www.sec.gov/divisions/corpfin/cf-noaction/2019/pocketful-of-quarters -inc-072519-2a1-incoming.pdf).
4. Commissioner Hester M. Peirce, Onsite: Remarks at the “Regulatory Transparency Project Conference on Regulating the New Crypto Ecosystem: Necessary Regulation or Chilling Future Innovation?”June 14, 2022 (https://www.sec.gov/news/speech/peirce-remarks-regulatory-transparency-project-conference).
5. Regarding: Blockchain Credit Partners d/b/a DeFi Money MarketSecurities and Exchange Commission File No. 3-20453 (August 6, 2021) (showing SEC’s application of Reeves test, which is another way to classify an asset as a security); see also, Reves v. Ernst & Young494 US 56 (1990).
6. SEC “Framework for Analyzing “Investment Contracts” of Digital Assets, https://www.sec.gov/files/dlt-framework.pdf2019.
Wow at 28-32.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.