Good afternoon and welcome to the Crypto Task Force’s inaugural roundtable, which will explore the complex legal issues involved in classifying crypto assets under the federal securities laws.
In the wake of the 2008 Financial Crisis, a person or group going by the name of Satoshi Nakamoto released a white paper describing a new peer-to-peer electronic cash system called Bitcoin that helped form an entirely new digitally native asset class.[1] Seventeen years later, market participants, lawyers, academics, policymakers, and regulators are still grappling with critical questions related to the status of these novel crypto assets under the federal securities laws.[2] This disagreement is most pronounced when it comes to application of the investment contract test established by the Supreme Court in its 1946 opinion in SEC v. W.J. Howey Co.[3] (known as the “Howey test”) to crypto assets.[4]
The challenges in applying Howey’s investment contract test are not unique to crypto. I have firsthand experience with it: as Chief Advisor to the California Corporations Commissioner, I argued before a California appellate court that the offering of a non-security certificate of deposit packaged with the separate receipt of a bonus payment constituted an investment contract.[5] Although the state court concluded that it was not,[6] other federal appellate courts have held that similar arrangements satisfy the Howey test.[7]
In the years following Howey, various courts of appeals are split on various nuances and other aspects of that decision. For example, does Howey require the pooling of investors’ funds and pro rata distribution of profits[8] or is it sufficient that investors need only share risk with the promoter?[9] In some circuits, the fortunes of all investors must depend on the promoter’s expertise,[10] but in other circuits, the fortune of the investor must be “interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties.”[11] Similarly, the courts of appeals are divided as to whether an investment contract requires post-sale efforts by the promoter or if “significant pre-purchase managerial activities undertaken to insure the success of the investment” suffices.[12]
Differences in opinions among various courts is not unusual. After all, a judicial opinion is limited to the particular facts and circumstances of that case. When judicial opinions have created uncertainty for market participants in the past, the Commission and its staff have stepped in to provide guidance.
For example, the Commission clarified the meaning of an investment adviser’s fiduciary duty under section 206 of the Advisers Act in response to industry demand.[13] The Commission also opined on the application of Howey to offers and sales of whisky warehouse receipts[14] and condominiums,[15] among other things. This approach of using notice-and-comment rulemaking or explaining the Commission’s thought process through releases – rather than through enforcement actions – should have been considered for classifying crypto assets under the federal securities laws. Today’s roundtable is an important first step in addressing that concern.
Thank you to the Crypto Task Force and panelists for your time in preparing for this roundtable. I look forward to the discussions to follow.
[1] See Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System (Oct. 31, 2018), https://bitcoin.org/bitcoin.pdf.
[2] This is exemplified by the fact that the same crypto asset is today listed as a security by one broker-dealer and a non-security on other platforms. See Benjamin Schiller, Ether’s Prometheum Test, CoinDesk (June 14, 2024), https://www.coindesk.com/opinion/2024/02/08/ethers-prometheum-test.
[3] 328 U.S. 293 (1946).
[4] See Lewis Cohen et al., The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are not Securities (Nov. 10, 2022), https://ssrn.com/abstract=4282385; Thomas Lee Hazen, Tulips, Oranges, Worms, and Coins – Virtual, Digital, or Crypto Currency and the Securities Laws, 20 N.C. J.L. & Tech. 493 (2019), //journals.law.unc.edu\/ncjolt/wp-content/uploads/sites/4/2019/05/Hazen_Final.pdf.
[5] See Brief for Respondent, Reiswig v. Dept’ of Corporations for the State of California, 50 Cal.Rptr.3d 386 (Oct. 27, 2006) (No. G036509), at 9-20.
[6] See Reiswig v. Dept’ of Corporations for the State of California, 50 Cal.Rptr.3d 386 (Oct. 27, 2006).
[7] See, e.g., Gary Plastic Packaging v. Merrill Lynch, 903 F.2d 176 (2d Cir. 1990); Safeway Portland Employees' Federal Credit Union v. C.H. Wagner & Co., 501 F. 2d 1120 (9th Cir. 1974).
[8] Revak v. SEC Realty Corp., 18 F.3d 81, 87 (2d Cir. 1994).
[9] SEC v. SG Ltd., 265 F.3d 42, 49 (1st Cir. 2001).
[10] Long v. Shultz Cattle Co., 881 F.2d 129, 140–41 (5th Cir. 1989).
[11] Revak, 18 F.3d at 88
[12] Compare SEC v. Life Partners, Inc., 87 F.3d 536, 546-48(D.C. Cir. 1996), rehearing denied 102 F.3d 587 (holding that pre-purchase efforts alone do not create an expectation of profits to be derived from the efforts of others) with SEC v. Mutual Benefits Corp., 408 F.3d 737, 743 (11th Cir. 2005) (concluding that significant pre-purchase efforts can create an expectation of profits to be derived from the efforts of others).
[13] See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Release No. IA-5248, Fed. Reg. No. 2019-12208, 2 (July 12, 2019), available at https://www.sec.gov/files/rules/interp/2019/ia-5248.pdf.
[14] Sale and Distribution of Whisky Warehouse Receipts, Securities Act Release No. 5018, 34 Fed. Reg. 18,160 (Nov. 4, 1969).
[15] Offers and Sales of Condominiums or Units in a Real Estate Development, Sec. Act Rel. 5347, 38 Fed. Reg. 1735 (Jan. 4, 1973), available at https://www.sec.gov/files/rules/interp/1973/33-5347.pdf.
