Director William Hinman Speaks About Digital Assets
Posted by Laura Anthony, Esq. on July 09, 2018
Director William Hinman Speaks About Digital Assets – On June 14, 2018, William Hinman, the Director of the SEC Division of Corporation Finance, gave a speech at Yahoo Finance’s All Markets Summit in which he made two huge revelations for the crypto marketplace. Director Hinman opens his speech with the gating question of whether a digital asset that is offered and sold as a security can, over time, become something other than a security. He then continues that in cases where the digital asset gives the holder a financial interest in an enterprise, it would remain a security. However, in cases where the enterprise becomes decentralized or the digital asset can only be used to purchase goods or services available through a network, the purchase and sale of the digital asset would no longer have to comply with the securities laws.
Reiterating the oft-repeated view of the SEC, Hinman notes that most initial coin or token offerings are substantially similar to debt or equity offerings in that they are just another way to raise money for a business or enterprise. In particular, funds are raised with the expectation that the network or system will be built and investors will get a return on their investment. The investment is often made for the purpose of the return and not by individuals that would ever use the eventual utility of the token. The return is often through the resale of the tokens or coins in a secondary market on cryptocurrency trading platforms.
In this case, the Howey Test is easy to apply to the initial investment. The Howey Test requires an investment of money in a common enterprise with an expectation of profit derived from the efforts of others. The emphasis is not on the thing being sold but the manner in which it is sold and the expectation of a return. Certainly, the thing being sold is not a security on its face; it is simply computer code. But the way it is sold – as part of an investment, to non-users, by promoters to develop the enterprise – can be, and in that context most often is, a security. Furthermore, in the case of ICOs, which are high-risk by nature, the disclosure requirements of the federal securities laws are fulfilling their purpose.
The securities laws apply to both the issuance or initial sale, and the resale of securities. In the case of coins or tokens, a careful analysis must be completed to determine if the resale of the coin or token also involves the sale of a security and compliance with the securities laws. If the network on which the token or coin is to function is sufficiently decentralized such that purchasers would not reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts, the assets may no longer represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful, such as with Ether and Bitcoin as discussed above.
An analysis as to whether an investment contract and therefore a security is being sold must be made based on facts and circumstances at any given time. Investment contracts can be made out of virtually any asset if it is packaged and promoted as such. Accordingly, although Bitcoin or Ether may not be a security on their own, if they were packaged as part of a fund or trust, they could be part of an investment contract that would need to comply with the federal securities laws.