By It has finally been confirmed. The Howey Test is officially the US Securities and Exchange Commission’s (SEC) benchmark for determining whether a crypto asset is a security or not.
The term “security” is used for defining a specific form of financial asset which can be traded and could fall into any category of financial instrument including cryptocurrencies and other forms of tokens.
Jay Clayton chairman of the SEC recently responded to queries on how the regulatory body approaches the classification of cryptocurrencies as securities. Just a few months back, a body of political representatives submitted their concerns pertaining to this with added support from the digital asset outlet Coin Center.
Clayton’s reply gives a clear answer to the SEC’s stance, the Howey test is the body’s “litmus test” for defining securities within the blockchain ecosystem and it is, in fact, possible for crypto assets, once they are classified as securities to shed this definition altogether.
This declaration was fitting enough for Coin Center to call this a reinforcement of previous statements made by the SEC, which cemented Ethereum as too decentralized to be classified as a security.
Coin Center’s Communications Director Neeraj Agrawal stated:
“This letter is another reference point for lawyers and developers to look to when determining how their project fits into current regulation. As far as reactions go: people welcome any clarity they can get.”
What Constitutes A Security When Pertaining To Crypto?
The Howey test has its roots in the outcome of a legal battle dating back to 1946. Simply put, it is a process for determining whether a specific asset can be defined as an investment contract aka security. This is common practice in enforcing federal securities laws.
Clayton’s letter asserted that SEC regulators recognize the “touchstone” of securities as “the presence of an investment in a common venture, premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”
He wrote:
“Your letter also asks whether I agree with certain statements concerning digital tokens in Director Hinman’s June 2018 speech, I agree that the analysis of whether a digital asset is offered or sold as a security is not static […].”
For a digital asset to be considered as a security depends on both facts and circumstances pertaining to the original investment. Clayton explained with the example that when investors (who pool assets to contribute to the funding of a project) no longer expect a developer or a group of developers to oversee managerial or entrepreneurial duties, their investment can longer be defined as a security.
He added:
“A digital asset may be offered and sold initially as a security because it meets the definition of an investment contract, but that designation may change over time if the digital asset later is offered and sold in such a way that it will no longer meet that definition.”
The SEC’s Vigorous Approach To Policing The Market:
Furthermore, Clayton also took the time to bolster his stance towards entrepreneurs within the crypto community. He stated that while many stakeholders have interacted with SEC regulators constructively many others have been found to prey on retailer excitement in efforts to commit fraud.
Clayton warned:
“The Division of Enforcement has brought a number of important cases in this area, and I have asked the Division’s leadership to continue to police these markets vigorously and recommend enforcement actions against those who conduct ICOs or engage in other actions relating to digital assets in violation of the federal securities laws.”
It’s clear that Clayton could be referencing the recent influx of settlements linked to fraudulent projects. For example, Floyd Mayweather and DJ Khaled were required to pay $750,000 for failing to disclose endorsement deals with the CentraTech crypto asset.
Furthermore, around the same time, SEC regulators also charged the founder of EtherDelta, a “decentralized” digital asset exchange for its management of an unregistered national securities exchange. The founder was forced to pay $300,000 for in penalties and fines.
Clayton added:
“The Commission acted swiftly to crack down on allegedly fraudulent activity in this space, particularly where the misconduct has targeted Main Street investors. Regardless of the promise of distributed ledger technology, those who invest their hard-earned money in opportunities that fall within the scope of the federal securities laws deserve the full protections afforded under those laws.”
To read Clayton’s full letter click here and for a comprehensive breakdown on how crypto asset classification could be altered over time, click here.
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