Are Digital Asset Transactions Always Securities Offerings?
By Andrew Massey and Evan Glover
On June 14, 2018, William Hinman, Director of the Division of Corporation Finance at the United States Securities and Exchange Commission, shared his views on whether digital assets (such as tokens or coins) that were originally offered in a securities offering can be subsequently sold in a manner that does not constitute a securities offering. CLICK HERE for the full remarks.
In some cases where a central enterprise is no longer being invested in, or where the digital asset is used for consumption (to purchase a good or service available through the network it was created), Hinman believes such an asset would not be considered a security. However, labeling a digital asset a “utility token” does not automatically cause the digital asset to become something that is not a security. Although the Supreme Court has stated that if someone is purchasing something for consumption, it is not a security, Hinman emphasized the Supreme Court’s stance that economic substance, not labels, of the transaction guides the legal analysis.
According to Hinman, central to the determination of whether a digital asset is a security is how it is being sold and the reasonable expectations of its purchasers. If the digital asset represents an investment in a common enterprise with an expectation of profit derived from the efforts of others (the investment contract test articulated in United States v. Howey), then the digital asset is a security and subject to the securities laws. However, a transaction may not represent a security offering if the network on which the digital asset is to function is sufficiently decentralized (like the Bitcoin and Ethereum networks, in their present state) because purchasers would no longer reasonably expect another to carry out essential managerial or entrepreneurial efforts.
Hinman stated this conclusion is consistent with his understanding of U.S. securities laws, which impose certain requirements (i.e., disclosures) on the offer and sale of securities, as the ability to identify an issuer or promoter on a decentralized network to make the requisite disclosures becomes increasingly difficult and less meaningful.