Section 5 Registration Requirements, DAO Tokens and ICOs
Posted by Attorney Laura Anthony on October 04, 2017
Section 5 Registration Requirements, DAO Tokens and ICOs- On July 25, 2017, the SEC issued its Report on an investigation into an ICO and related activities by the DAO, an unincorporated entity, Slock.it UG, a German corporation, and various principals and participants.
Section 5 of the Securities Act of 1933 requires the registration of all offers and sales of securities unless there is an available exemption. The registration provisions are based on “full and fair disclosure” of all material information for an investor to make an informed investment decision, including detailed information about the issuer’s financial condition, identity and background of management and the price and amount of securities to be offered.
Section 5 of the Securities Act, like many provisions in the securities laws, is written in the inclusive, such that all offers and sales are covered unless an exemption is available pursuant to statute or case law. Section 5 states that “unless a registration statement is in effect as to a security, it is unlawful for any person, directly or indirectly, to engage in the offer or sale of securities in interstate commerce.” A violation of Section 5 does not require intent.
The SEC begins its analysis of the DAO Tokens by reference to the definitions of a security found in both Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Securities Exchange Act. Both definitions include the term “investment contract,” which has been famously defined by the U.S. Supreme Court in the case of the SEC v. W. J. Howey in 1946, as an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.
Under the Howey Test, whether an investment instrument is a security requires a substance-over-form analysis. The Howey Test defines an investment contract as follows:
“… an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party…. Such a definition… permits the fulfillment of the statutory purpose of compelling full and fair disclosure relative to the issuance of the many types of instruments that in our commercial world fall within the ordinary concept of a security…. It embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”
Applying the Howey Test, courts have interpreted a security to include such diverse items as citrus groves, warehouse receipts, chinchillas, minks, diamonds, bullion, pay phones, real estate and equipment, and condominium units, when they were offered or sold under circumstances involving the investment of money and an expectation of a return through the efforts of others.