The SEC Reaffirms its Stance: Most Tokens are Securities

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The crypto token asset class has grown substantially in the last couple of years, drawing the watchful eyes of regulators. While the emerging world of crypto has created more questions than answers, the U.S. Securities and Exchange Commission (“SEC” or “Commission”) remains clear that investor protection remains at the forefront of its mission and that mission extends to where money is to be made in connection with the offer or sale of securities. To this end, the Commission has increased its regulation of crypto asset tokens, and crypto industry participants at all levels of engagement with this market should pay attention.

On October 3, 2022, the SEC brought charges against someone you might not expect to be reading about in a securities law article. Kim Kardashian was charged with Section 17(b) of the Securities Act of 1933 (“Securities Act”),for unlawfully promoting a crypto asset token (“Token”) on social media.1 The SEC’s findings revealed that Kardashian touted Emax Tokens from online company EthereumMax without disclosing that she received $250,000 for doing so. The anti-touting provision of the Securities Act forbids individuals from touting a security without disclosing the amount paid, along with the source and the nature of those payments.2 In reaching a settlement with the Commission, Kardashian agreed to pay $1.26 million in penalties, disgorgement, and interest, cooperate with the Commission’s ongoing investigation, and forgo promoting any crypto asset securities for three years.3 Shortly thereafter, SEC Chair Gensler published an online video warning the public to take caution in making crypto investment decisions based solely on the recommendations of a celebrity or influencer.4

Most Tokens are Securities

The SEC’s order on Kardashian’s social media post is a reminder of the Commission’s increased interest in regulating the crypto market and prioritizing investor protection. Just last month, Gensler reiterated his belief that a “vast majority” of Tokens are securities “covered under the securities laws.”5 According to Gensler, most Tokens are “investment contracts” per the Supreme Court’s Howey test.6 Under Howey, an investment contract is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”7 Because the investing public is buying or selling Tokens with the aim of seeking profits from the efforts of others, Gensler claims that most Tokens pass muster under Howey.8

A small number of Tokens that “represent a significant portion of the crypto market’s aggregate value” may not be securities.9 These Tokens are a commodity and act as replacements for sovereign currencies.10 For example, “Bitcoin,” the first crypto token, is akin to “digital gold” that trades like a “precious metal,” according to Gensler.11 Stablecoins, on the other hand, are similar in nature to money market funds, bank deposits, and other securities, which may warrant regulation.12 “Depending on their attributes, such as whether these instruments pay interest, directly or indirectly, through affiliates or otherwise; what mechanisms are used to maintain value; or how the tokens are offered, sold, and used within the crypto ecosystem, they may be shares of a money market fund or another kind of security” that would necessitate registration with the SEC.13

Conclusion

The SEC is making strides in increasing regulation and enforcement of the roughly $2 trillion crypto market.14 In May of this year, the SEC announced its decision to nearly double the size of the newly renamed “Crypto Assets and Cyber Unit” within the Division of Enforcement.15 The expanded unit is expected to investigate securities law violations related to crypto asset offerings, exchanges, lending and staking products, decentralized finance (DeFi) platforms, non-fungible tokens (NFTs), and stablecoins.16 A further indication of the SEC’s commitment to policing the crypto space, the SEC requested 125 new hires, with 33 allocated to the Crypto Assets and Cyber Unit, for Enforcement in its recent FY 2023 Congressional Budget Justification.17 This is a significant increase from the nine positions requested in FY 2022.18

The SEC’s recent order and Gensler’s accompanying statements indicate that crypto industry participants should work early on to ensure compliance with regulators. Gensler suggests that such cooperation is “far less costly to do [] from the outset” and would benefit all parties.19 Crypto industry participants concerned about reducing crypto enforcement risks or how to engage with the Commission should seek legal counsel on navigating this newly evolving regulatory landscape.

1In re Kimberly Kardashian, Securities Act Release No. 11116 (Oct. 3, 2022), https://www.sec.gov/litigation/admin/2022/33-11116.pdf.

2Section 17(b) of the Securities Act.

3Id.

4Gary Gensler, Chair, U.S. Sec. and Exch. Comm’n, Office Hours with Gary Gensler: Use Caution with Celebrity Endorsements of Investment Products, YouTube (Oct. 3, 2022), https://www.youtube.com/watch?v=vbZS6tYQKIM.

5SEC v. W. J. Howey Co., 328 U.S. 293 (1946); see also Gary Gensler, Chair, U.S. Sec. and Exch. Comm’n, Kennedy and Crypto (Sep. 8, 2022), https://www.sec.gov/news/speech/gensler-sec-speaks-090822.

6Id.

7Howey, 328 U.S. at 298−99.

8Gensler, supra, at note 5.

9Id.

10Public Statement, Jay Clayton, Chairman, U.S. Sec. and Exch. Comm’n, Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017), https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11.

11Gensler, supra, at note 5.

12Id.

13Id.

14Gary Gensler, Chair, U.S. Sec. and Exch. Comm’n, Prepared Remarks of Gary Gensler On Crypto Markets delivered at Penn Law Capital Markets Association Annual Conference (April 4, 2022), https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422.

15Press Release, U.S. Sec. and Exch. Comm’n, SEC Nearly Doubles Size of Enforcement’s Crypto Assets and Cyber Unit (May 3, 2022), https://www.sec.gov/news/press-release/2022-78?utm_medium=email&utm_source=govdelivery.

16Id.

17U.S. Sec. and Exch. Comm’n, Fiscal Year 2023: Congressional Budget Justification Annual Performance Plan at 6 (2022), https://www.sec.gov/files/fy-2023-congressional-budget-justification-annual-performance-plan_final.pdf.

18U.S. Sec. and Exch. Comm’n, Fiscal Year 2022: Congressional Budget Justification Annual Performance Plan at 4 (2021), https://www.sec.gov/files/fy-2022-congressional-budget-justification-annual-performance-plan_final.pdf.

19Gensler, supra, at note 5.

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