This is Howey. Do it.
April 30, 2019 | By Lacey Shrum
Earlier this month, the SEC posted guidance and a No-Action letter to Turnkey Jets, giving more insight into the particular way the Howey test is applied to tokens. To recap, the Howey test is met when:
- There is an investment of money
- To a common enterprise
- With a reasonable expectation of profits
- Dependent on the efforts of others
If what you are offering to third parties satisfies all four prongs, then the offering needs to be registered or fit within an exemption from registration. The fourth prong steals the show in the SEC guidance and the SEC takes considerable time in listing factors that lead to this prong being satisfied.
Active Participant
The SEC coins the phrase “Active Participant” (AP) and describes it as one who “provides managerial efforts that affect the success … and investors reasonably expect to derive profit from those efforts.” An AP can be a promoter, sponsor, or other third party. The AP comes down to control; if the AP has control over the product, the direction, or the pocket book, the closer it is to meeting that fourth prong. Factors to consider: maintaining the functionality of the network or digital asset, controlling the creation or issuance of the digital asset, and determining how to deploy funds raised in a token sale.
Token Reevaluation
We are introduced to the possibility of a token reevaluation to determine if the token is no longer a security. However, the SEC uses the influence and work of the AP to determine, versus the adoption, usage or effects of the token itself.
Turnkey Jet Tokens
The SEC provided a No-Action letter to Turnkey Jets for their token offering, so long as it followed a few simple guidelines. No-Action letters are written by the SEC to indicate that the staff will not recommend legal action against the recipient for its actions. Turnkey offered its jet membership through a token offering versus a piece of paper or an internal registry, claiming the token aspect made the use of the membership more efficient (probably not in this case, but hey).
Expectation of Profits
The No-Action letter is in response to Turnkey’s request for a no-action letter which argues that the issued tokens do not meet the third prong of the test because the program will not return cash by way of profits, returns, dividends, etc. to holders, and holders have no ability to transfer ownership.
Attorney Responsibility
The SEC previously said it would hold attorneys and other service professionals responsible in fraudulent capital raises, whereas in Turnkey it specifically says it will not pursue action because Turnkey proceeded with its token sale on advice of (arguably good, judging by the letter) counsel.
Bitcoin Burn
Article II, Paragraph A of the guidance highlights the first prong of the test, “the investment of money,” which is described as “when a digital asset is purchased in exchange for value … in the form of real (or fiat) currency.”
Parting Thoughts
The Guidance is issued by the SEC’s Strategic Hub for Innovation and Financial Technology, and it specifically discloses that “this is not a rule, regulation, or statement of the Commission, and that the Commission has neither approved nor disapproved its content.” Think of it as, “Here we are, here is what we are thinking and working on… please leave us alone now about ICO’s. K thx.”
The No-Action letter is specific to the Turnkey facts and an application of Howey applied to Turnkey’s specific business model. This is neither law nor precedent, but simply information.
If you are taking money from other people, always talk to a securities attorney before you do. Even if your offering or token may be a security, you still may be able to raise capital through an exemption the old fashioned way. Each situation is different, and as you can see, there is no easy, black/white answer.
Where does this leave us? The clarity needle has been moved, but just ever so slightly. This gives us guidance and information but arguably not a bright line rule. But, we have a bit of a path cut as the SEC has reviewed a token offering and determined it not to be a security.
About the Author(s)
Lacey Shrum
Lacey is an attorney at Vela Wood where she serves businesses that use blockchain technology and digital assets. She serves as a subject matter expert and expert witness to attorneys and advisors as they encounter digital assets in their traditional legal practice.
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