The Securities and Exchange Commission (“SEC”) confirmed on July 25 in an investigative report that the Howey test provides the correct starting point to determine whether an Initial Coin Offering (“ICO”) or token sale is a security. The SEC investigated a token offering by a virtual organization called “The DAO”, which commonly stands for Decentralized Autonomous Organization. In short, The DAO sold tokens to investors for the purpose of raising funds to invest in additional projects.
On the facts of the DAO token sale, there was little question the DAO was issuing securities under the Howey Test. The SEC used the DAO investigation to illustrate existing federal securities laws apply to this emerging method of raising funds to finance projects, though the SEC choose to not take action against the DAO or its developers. It is important to note that the SEC did conclude that all ICO’s or token sales are securities under the Howey Test. Each ICO must be analyzed on the facts and circumstances surrounding the ICO or the token sale. The SEC did not provide a clear line.
Notably, the SEC specifically stated the exchange and resale of ICO’s or tokens qualifying as securities are regulated under federal securities laws. For this reason, it is important for all cryptocurrency exchanges to review and assess the status of each coin or token on their exchange.
Participants in the ICO market outside the United States must remember when issuing ICO’s or tokens and/or reselling coins or tokens to investors in the United States that they still subject themselves to US securities laws and the SEC maintains jurisdiction over the issuance and exchange of securities in the United States.
Regardless of the terminology used by issuers of coins or token, it is important to understand that if the substance of your creation or action will be the deciding factor. If the substance of your coin or token is similar to a prior creation or action found to be regulated under federal securities law, then regulators and the courts will focus on the substance rather than the terminology. In other words, regardless of what you call it, if it meets the test for a security, the SEC and the courts will treat it as a security
As noted, the SEC “guidance” provides no definitive answer on which coins or tokens will qualify as securities. The SEC confirms the Howey test as the proper analytical framework. The report serves as notice to all upcoming ICO’s and token sales that the SEC may look to take a more active role in the space, with the aim of protecting investors from the growing potential fraud and deception in the ICO market.
If you plan to issue an ICO or token sale to US residents, tread carefully, be mindful of the application of securities laws, and understand the emerging regulatory cost and risks associated with ICO’s and token sales.