The SEC’s Limited Guidance on Crypto Tokens in No-Action Letters

The Securities and Exchange Commission (SEC or Commission) has been accused of “regulation by enforcement” when it comes to the standard for determining whether a crypto token is a security. Part of this stems from the fact that securities were defined by statute in 1933 using a specific list of enumerated financial instruments.^[1] Obviously, legislators were not specifically considering crypto tokens when the law was written. However, courts — and the SEC and state regulators by extension — have decided that the economic reality of how the instrument is used is most important, not the specific form or technological embodiment. In particular, the precise bounds of one of the listed instruments, the “investment contract,” has been used with the established “Howey Test” as a way for the SEC to label many different instruments as securities.

There is a significant disparity in views between the SEC and many in the crypto industry on whether clear guidance has been provided. This began after the SEC issued its report on its investigation into the entity called The DAO, in which the SEC concluded that the crypto tokens it used were securities. The SEC published on its FinHub a “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which gives a nonbinding laundry list of factors that indicate when a token issued through an initial coin offering may be a security. Furthermore, the SEC has shown through recent enforcement actions and the statements of its chair, Gary Gensler, that it believes most crypto tokens are securities. The SEC is also likely to view the recent decision in SEC v. LBRY, Inc., which found the LBC token to be a security as a matter of law, to confirm this stated position further.

Here, we attempt to summarize the affirmative guidance that the SEC has provided concerning factors considered when a crypto token is not a security. These factors were stated by the SEC in three no-action letters.^[2] Unfortunately, the SEC’s guidance in these no-action letters includes multiple factors, with no explanation on which, if any, factors are dispositive in determining whether or not a crypto token is a security.

Summary of Factors in Published No-Action Letters

As of the writing of this article, the SEC has published three no-action letters related to whether crypto tokens are securities under the Securities Act of 1933: Section 2(a)(1). These no-action letters are for the crypto tokens proposed by TurnKey Jet, Pocketful of Quarters and IMVU. In each, the party submitted a letter that provided the company’s background, what it was attempting to do with the crypto token and case law supporting its position. Notably, each of these tokens followed a straightforward “utility token” model with little potential for speculative use. In response, the SEC provided a list of factors it apparently considered to determine that it would not recommend an enforcement action to the Commission. The following reflects the common factors that were considered.

The Takeaway

As shown, these tokens have a number of factors in common. Universally, they include that the tokens sales are not being used to build the platform and tokens can be used immediately for their intended purpose. Additionally, all include the requirement that they are marketed for their intended utility and not for any potential increase in value. The other factors may be considered by the SEC depending on the circumstances of the particular token but do not appear to be required under all circumstances.

As mentioned, the SEC has only addressed factors that apply to what could be classified as pure utility tokens. The SEC has not addressed factors that would be common to many other frequently used types of crypto tokens. Notably, the SEC has not addressed if and when a crypto token is “sufficiently decentralized” so that it is no longer a security, as suggested was possible in a 2018 speech by former SEC Director of Corporate Finance William Hinman. The SEC has also not addressed whether the token being an NFT has weight in its analysis or how governance tokens would be considered. The SEC has left these particular considerations up in the air for the time being.

^[1] _{Defined as “any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘security’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.” Securities Act of 1933 at Sec. 2(a)(1).}

^[2] _{A no-action letter is a statement from the staff of the SEC that it would not recommend that the Commission take enforcement action against the token if it was sold without being registered as a security. To receive a no-action letter, a requestor submits to the SEC a letter in which it lays out how the crypto token will be used and identifies applicable law supporting its conclusion that its crypto token is not a security.}

^[3] _{Only Approved Accounts (defined as “Developers and Influencers”) that can exchange the tokens for ETH.}

^[4] _{“Open Wallets” that can sell the tokens back for fiat currency.}

^[5] _{Although KYC/AML are not specifically mentioned by the SEC, it does mention that the tokens could only be used in internal wallets at TurnKey Jet. These wallets are subject to KYC and AML provisions.}

^[6] _{Approved Accounts (defined as “Developers and Influencers”) that can redeem tokens are subject to KYC and AML checks.}

^[7] _{“Open Wallets” that can transfer the token out of the platform are subject to KYC and AML.}