Article by Forbes: Andrea Tinianow
In his fireside chat this afternoon at Cardozo Law School with Aaron Wright, Associate Clinical Professor of Law and Director of the Cardozo Blockchain Project at Cardozo Law School, William Hinman, Director, Division of Corporate Finance, covered a range of topics related to the regulation of digital securities.
Director Hinman started off by explaining that his division continues to spend more and more time on the question of what is a security and how the security law framework should be applied to digital securities.
Much of Director Hinman’s comments amplified the facts and circumstances test which is embodied in the Howey test. He touched on the fact that because the United States is a common law country and not a civil law jurisdiction many of our rules are based on precedent. In the blockchain context, this means that U.S. securities laws don’t provide bright line rules for determining what is or is not a security. Director Hinman recognized that this can create difficulty for some.
Director Hinman noted that certain civil law countries that provide bright line rules actually use the very same indicia (or criteria) that the SEC uses in it securities analyses.
Andrew Hinkes, an attorney with Carlton Fields’ Blockchain and Digital Currency practice agreed, stating, “other jurisdictions with a so-called bright line, often perform the very analysis animated in the Framework document created by the SEC to assist blockchain entrepreneurs. The only difference is that the analysis is crafted as a rule and not as a flexible analytical framework.”
Director Hinman explained: We are concerned about the bright line approach, that [entrepreneurs] will get right up to the line. We think that a lot of the activities are facts and circumstances dependent.
Those who follow this area of the law would note that there is little-to-no case law directly on the topic of what constitutes a digital security. As a result, the SEC has made an effort to elucidate relevant issues through outreach to the blockchain community. Director Hinman and others give talks like the one at Cardozo today, and provide written guidance, such as the Framework which discusses the Howey test and how that applies to digital securities. Director Hinman also pointed to the SEC’s FinHub which actively works with entrepreneurs to answer questions and provide guidance, and its director Valerie Szczepanik who serves as the SEC’s senior advisor for digital assets innovation.
Director Hinman commented that ether and bitcoin have evolved and don’t involve a central party (which would mean that they are not securities). But he did reflect on the fact that he could imagine a set of circumstances where bitcoin or ether could become a security based on certain circumstances. He also said that most of the Initial Coin Offerings (ICOs) that we are talking about have a central party (and therefore would be securities). Director Hinman further explained that because there are so many variables with respect to most ICOs, if you were to try to draw bright lines, there would be a lot of lines.
Veteran blockchain attorney Cathy Yoon suggests therein lies the problem, stating, “how can you expect innovation to flourish where there is so much ambiguity.”
Director Hinam suggested that when considering whether a digital asset is a security, the SEC seeks to determine whether the consumer is buying the token to use the service or to speculate. He referred to Pocketful of Quarters (PoQ) which received a no-action letter from the SEC, and explained that it was pretty clear that people in that case would be buying the Quarters tokens to play online games – i.e., consume services (and not for speculative purposes).
“Director Hinman did a great job explaining the SEC’s rationale behind granting the first relief for an issuer of ERC-20 tokens to Pocketful of Quarters”, said Lewis Cohen of DLx Law, the lawyer who represented PoQ and submitted the requesting letter to the SEC. “Of particular note, Director Hinman observed that the SEC Staff were able to get comfortable with a greater degree of transferability in the case of PoQ than they did in the preceding no-action letter” Cohen added.
In considering when in the lifecycle of a blockchain company it is appropriate to issue tokens, Director Hinman offered that token issuances should come after companies build out their infrastructure through traditional fundraising methods. If you create your network first and then offer a token, it could save you heartache down the road. He also urged folks to retain strong counsel, which is good advice.