The SEC has issued a “Framework for ‘Investment Contract’ Analysis of Digital Assets” (the ‘Framework’) that provides the Division of Corporation Finance’s guidance on how to evaluate whether digital assets are “investment contracts,” which are a type of security. The SEC simultaneously issued a No Action Letter to TurnKey Jet, Inc. in which, applying the principles of the Framework, it found that the proposed initial coin offering (ICO) would not be an issuance of securities subject to the securities laws. Importantly, the Framework may apply to a variety of market participants involved in the digital asset ecosystem, including those engaged in activities such as: offering, selling, or distributing; marketing or promoting; buying, selling, or trading; facilitating exchanges; holding or storing; offering financial services such as management or advice; or other professional services.
The Framework provides guidance on the applicability of the Howey test – based on a well-known Supreme Court case construing the definition of an investment contract – to digital assets like tokens. The Howey test states that an investment contract exists when there is (1) an investment of money in a (2) common enterprise with a (3) reasonable expectation of profits to be derived from the efforts of others. The focus of the Framework is on the third prong, as the “investment of money” and “common enterprise” prongs are easily met by most transactions.
In analyzing whether the third prong has been met, the Framework provides that the SEC will evaluate a number of criteria, including (a) reasonable purchaser expectations of reliance on the efforts of an active participant, which are “essential managerial efforts which affect the failure or success of the enterprise,” (b) reasonable purchaser expectations of profits, and (c) the economic reality of the transaction, including whether the digital asset is being offered and sold for use or consumption by the purchaser.
The bases for the SEC’s conclusion in the No Action Letter, which applies the Framework’s principles, include that:
- the company will not use any funds from the ICO to develop their platform, network, or app;
- the tokens will be immediately usable for their intended functionality;
- transfers of the tokens will be restricted only to TurnKey Jet wallets (i.e., cannot be transferred to external wallets);
- the tokens will be fixed at a cost/value of $1; and
- the marketing of the token emphasizes the functionality and not the potential for the increase in market value.
While neither the Framework nor the No Action Letter contains any conclusions or statements of policy that should be considered groundbreaking, each provides a useful benchmark moving forward for analyses of ICOs and consolidates the SEC’s previous statements of policy, which were spread across a number of speeches and the DAO Report.