A Nuanced Look At Crypto Assets as Securities In Light of SEC Comments
On June 14, 2018, the Securities and Exchange Commission (SEC) director of corporate finance made waves in the cryptocurrency space when he commented at Yahoo Finance’s All Market Summit: Crypto that ether is not a security. The statement carries weight.
His words led to a flurry of speculation about the potential implications of what this means for Ethereum as well as the larger cryptocurrency ecosystem with regards to development and regulation.
It should be noted that the shifting status of regulatory terms can be confusing and contrary to the logic of programming languages that cryptocurrencies use. As a result, Adam B. Levine dedicated much of Episode #371 of his show, Let’s Talk Bitcoin, to clearing up misconceptions about the SEC’s stance. To do this, he invited lawyer and programmer Stephen Palley for an in-depth interview.
Discretion in the Legal World
Levine began by reading an abridged version of the SEC director’s speech, or as he dubbed it, “When Howey Met Gary.” Next, Levine spoke with Palley to hammer out what the speech is stating. In the speech, Director William Henman recalled the 1946 Supreme Court ruling of SEC v.s. W.J. Howey Co., which first laid out the terms for what defines an asset, such as land purchases or services contracts, to be a government regulated by the Securities Act.
Under this act, the form of the contract itself is of less importance than the actual economic substance of these transactions. This means that any number of assets can still qualify as securities as long as they fulfill certain qualifications.
- Assets being specifically promoted by a group with a controlling interest in daily operations;
- Assets being purchased by consumers under some reasonable expectation of profit; and
- Assets wherein there is significant asymmetry of information between the promoters and purchasers of an asset.
Securities regulations primarily exist to ensure a third party, namely a regulatory entity, is well-informed enough to judge if there is a reasonable guarantee of a safe investment, without compromising trade secrets that promoter firms do not want made public.
Furthermore, Henman stated that the decentralization offered by cryptocurrency models such as ether prevent a single promoter entity from actually gaining significant leverage in information or control that consumers would need protection from. This means certain applications of cryptocurrencies can be sold as securities, but the format itself does not require this level of regulation.
A Legal Perspective
Palley, a practicing lawyer of 20 years, explained some of the concerns that have made this possible ruling particularly sticky for the world of cryptocurrencies. Palley claimed that specific types of legal contracts are similar to executable programmable code, yet legal verdicts operate in a sufficiently more complex way. Legal verdicts require contextual considerations that must be made of the technical form as well as the economic realities of various interactions. This ambiguity is often understood by programmers that, legally, the most uncharitable interpretation of a ruling will be applied unilaterally.
Palley gave an example by comparing the factors which make ether not a security while conceivably making ripple qualify as a security. Evidence for this is that the original developers of Ethereum have largely distanced themselves from the project so that they do not form a distinct entity still invested in the profit and daily operations of this platform. Ripple, on the other hand, is still one entity. Ethereum also held back a much smaller percent of ether tokens for their developers while Ripple held onto enough tokens to retain a controlling interest. For these reasons, there are easily observed asymmetries in the Ripple platform that could well classify its assets as securities.
The Future of Crypto-Based Tort Action
Palley went on to ruminate on the implications that recent lawsuits against Tezos might have on future civil suits against cryptocurrency developers. Using his inside experience as a practicing lawyer working in the cryptocurrency space, Palley stated that many civil class-action suits are unable to find plaintiffs even in the event of potentially dubious actions for the simple reason that no one wants to sue a firm that is continuing to make them money. After all, tort actions of this nature typically take place as an attempt to jump on potential violations to regain lost investment money through damages if the investments themselves are no longer profitable.
Palley claimed that the lawsuits against Tezos fall under this category. He stated that Tezos has conducted its own business with enough good faith that the plaintiffs allege that the business model itself is somehow improper, rather than Tezos specifically engaging in improper decisions at the micro-level. Under this trend, Palley speculated that the most significant factor in uncharitable interpretations of cryptocurrency-related laws will take place under market contracts for the space as a whole.