The Securities and Exchange Commission (SEC) is interested in cryptocurrency and related assets because they are considered securities and fall under the agency’s jurisdiction. The SEC’s role is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The SEC has taken enforcement actions against some cryptocurrency-related companies and individuals who have engaged in illegal or fraudulent activities, such as initial coin offerings (ICOs) that were unregistered securities offerings, or who have made false or misleading statements about their products and services.
In recent years, the SEC has issued a number of guidance documents and enforcement actions related to cryptocurrency, in order to provide clarity to the industry and ensure that cryptocurrency companies are operating in compliance with federal securities laws. The SEC has also made it clear that it will take enforcement action against any company or individual that violates these laws.
What is considered a security
A security is a tradable financial asset, such as stocks, bonds, or options, that represents ownership in a company or a claim on its assets and earnings. In the United States, the definition of a security is provided by the Securities Act of 1933, and it is generally understood to include any investment contract, regardless of whether it is called a security or not.
The definition of an investment contract, which is a type of security, is broad and includes any arrangement where a person invests money in a common enterprise and is led to expect profits primarily from the efforts of others. This definition has been interpreted to encompass a wide range of financial instruments, including stocks, bonds, and investment funds, as well as newer assets like cryptocurrency and token offerings.
The SEC has applied this definition to cryptocurrency and has stated that many cryptocurrencies and initial coin offerings (ICOs) are considered securities and therefore fall under the SEC’s jurisdiction. This means that companies offering these assets must comply with federal securities laws, including registering their offerings with the SEC and providing investors with accurate and complete information about the risks and potential benefits of their investments.
So Crypto “CURRECNY” is a security?
Cryptocurrencies can be considered both a currency and a security, depending on the specific circumstances of each case.
In their most basic form, cryptocurrencies, such as Bitcoin, are used as a medium of exchange, similar to traditional fiat currencies. In this sense, cryptocurrencies can be seen as a type of currency.
However, many initial coin offerings (ICOs) and other cryptocurrency offerings have features that the SEC and other regulatory agencies consider to be characteristic of securities. For example, some ICOs have been structured as investments in which buyers expect to earn a profit based on the efforts of others, such as the developers or managers of the project. In these cases, the ICOs and the underlying cryptocurrencies can be considered securities and subject to federal securities laws.
The determination of whether a cryptocurrency or ICO is a security is based on the specific facts and circumstances of each case and is guided by the Howey Test, a framework established by the Supreme Court in 1946 to determine whether an investment is a security.
Explaining the Howey Test
The Howey Test is a legal test used to determine whether an investment contract is considered a security under U.S. federal and state securities laws. It was established in the landmark case of SEC v. W.J. Howey Co. in 1946, and is still used today to evaluate the character of an investment contract. The test is significant because the sale of securities must comply with certain disclosure and registration requirements, and the Howey Test helps determine whether these requirements apply.
The Howey Test consists of four elements that must be met in order for an investment contract to be considered a security:
- An investment of money The first element of the Howey Test requires that the investment must involve a contribution of money. This can include cash, checks, wire transfers, or other forms of payment. The investment must also be made with the expectation of profits, rather than for personal use or consumption.
- In a common enterprise The second element of the Howey Test requires that the investment must be made in a common enterprise, meaning that the profits of the investment are expected to be derived from the efforts of others. This can include a company, a partnership, a trust, or other similar entity. It is not necessary for the investor to have control over the enterprise, but the enterprise must be managed in a way that the profits are derived from the efforts of others.
- With the expectation of profits The third element of the Howey Test requires that the investment must be made with the expectation of profits. The profits can be in the form of dividends, interest, capital appreciation, or other forms of return on investment. The expectation of profits must be a significant motivating factor for the investment, and must be reasonably likely to occur.
- Derived solely from the efforts of others The fourth and final element of the Howey Test requires that the profits must be derived solely from the efforts of others. This means that the investment must not be dependent on the personal efforts of the investor. For example, an investment in a passive real estate investment trust (REIT) would satisfy this element, while an investment in a franchise business would not.
If all four elements of the Howey Test are met, then the investment is considered a security and must comply with applicable securities laws. If any of the elements are not met, then the investment is not considered a security and is not subject to securities regulations.
It’s worth noting that the Howey Test is not a strict formula, and the analysis of whether an investment contract is a security can be complex and fact-specific. The test has been applied to a wide variety of investment arrangements and is not limited to traditional forms of securities such as stocks and bonds. The U.S. Supreme Court has described the test as “flexible” and “not capable of precise definition,” which has allowed it to be applied to new and evolving forms of investments.
In recent years, the rise of cryptocurrency and initial coin offerings (ICOs) has led to increased scrutiny of investment contracts under the Howey Test. Many ICOs involve the sale of tokens that represent an ownership interest in a blockchain-based enterprise, and the SEC has taken the position that many of these tokens are securities that must comply with federal securities laws. The application of the Howey Test to ICOs has been the subject of much debate and legal challenge, but the basic principles of the test remain unchanged.
Who is the SEC going after?
The Securities and Exchange Commission (SEC) has taken enforcement action against a number of cryptocurrency-related companies and individuals for various violations of federal securities laws. Some of the cryptocurrencies and initial coin offerings (ICOs) that have been the subject of SEC enforcement action include:
- Telegram: The SEC settled with Telegram Group Inc. in June 2021 for conducting an unregistered, $1.7 billion securities offering of its cryptocurrency, Gram.
- Kik Interactive: The SEC sued Kik Interactive Inc. in 2019 for conducting an unregistered $100 million securities offering of its cryptocurrency, Kin.
- Ripple Labs: The SEC filed a lawsuit against Ripple Labs Inc. in December 2020 for conducting an unregistered, ongoing securities offering of its cryptocurrency, XRP.
- Longfin Corp.: The SEC sued Longfin Corp. in 2018 for alleged market manipulation and other violations in connection with its initial coin offering (ICO) of its cryptocurrency, LFIN.
These are just a few examples of the many enforcement actions taken by the SEC related to cryptocurrency. The SEC has made it clear that it will continue to monitor the cryptocurrency industry and take enforcement action against any company or individual that violates federal securities laws.
It’s important to note that the SEC’s focus is not on any particular cryptocurrency, but rather on ensuring that all offerings and trading of cryptocurrencies and other assets that fall under the definition of securities comply with federal securities laws.
How does that affect me the retail buyer / investor?
The SEC’s enforcement actions against cryptocurrency-related companies and individuals can affect retail investors in several ways:
- Protection of investments: By taking enforcement action against illegal or fraudulent activity in the cryptocurrency market, the SEC aims to protect retail investors from losing their hard-earned money.
- Providing information: The SEC requires companies offering securities, including cryptocurrencies, to provide investors with accurate and complete information about the risks and potential benefits of their investments. This helps retail investors make informed decisions about where to invest their money.
- Maintaining fair markets: The SEC is responsible for enforcing federal securities laws and maintaining fair, orderly, and efficient markets. By taking action against illegal or manipulative behavior in the cryptocurrency market, the SEC helps to ensure that retail investors have equal access to information and that the markets are functioning fairly.
- Deterring illegal activity: The SEC’s enforcement actions against cryptocurrency-related companies and individuals serve as a deterrent to others who may be considering engaging in similar illegal or fraudulent activity.
In general, the SEC’s enforcement actions in the cryptocurrency market are designed to protect retail investors and maintain fair and efficient markets. By taking action against illegal or fraudulent activity, the SEC helps to create a safer and more trustworthy environment for retail investors to invest in cryptocurrency and other assets.