Since the Securities and Exchange Commission (SEC) issued the DAO Report in June 2017, pulled the plug on the Munchee Inc. ICO in December 2017, and then initiated its “Crypto Industry Sweep” in early 2018, companies have been waiting anxiously for clear guidance from the regulator on what types of digital assets fall under the SEC’s jurisdiction. Nearly two years later, the SEC responded with its “Framework for ‘Investment Contract’ Analysis of Digital Assets” (Framework), a 13-page memorandum that describes the factors used by SEC staff for assessing whether digital assets are “investment contracts” subject to federal securities laws. After providing a high-level overview of the Framework and explaining how the SEC staff is likely to analyze digital assets, this article examines the concept that digital assets can reach a tipping point—an “evolutionary moment” in their development—where they transform from a security to non-security. While SEC staff referenced this concept in passing during two speeches last year, it was not until the issuance of the Framework that it was more formally addressed.
Overview of the Framework
The Framework is intended to serve as “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.” It centers on the application of the Supreme Court’s Howey test—the long-recognized standard for determining if an instrument or contract qualifies as an “investment instrument” and thus a security or whether a scheme or transaction (e.g., the sale of a digital asset) qualifies as a sale of securities. The Howey test requires (1) an investment of money; (2) in a common enterprise; (3) with an expectation of profits; (4) predominantly derived from, or in reliance on, the efforts of others. Federal securities laws require that all offers and sales of investment contracts and other securities be registered or qualify for an exemption from registration.
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