The Securities and Exchange Commission may be getting set to clear up confusion around whether and under what conditions initial coin offerings, and possibly alt-coins like ether and ripple, constitute securities.
William Hinman, a key SEC official for formulating policy on bitcoin and blockchain, is speaking Thursday at Yahoo’s All Markets Summit: Crypto in San Francisco.
Hinman, head of the Division of Corporate Finance, will likely attempt to clear up two of the biggest hurdles cryptocurrencies are facing: Are ICOs securities and required to register with the SEC, and are alt-coins like ripple and ether securities?
These issues, along with the SEC’s refusal to approve a bitcoin ETF, have been a significant cloud over the development of cryptocurrencies and the blockchain buildout.
“No one is quite sure what the rules are,” JJ Kinahan, chief market strategist for TD Ameritrade, told CNBC. “Getting clarity about what’s allowed and what’s not is always helpful to the markets.”
But SEC Chairman Jay Clayton says the agency has been pretty clear on what a security is. He spoke at the Sandler O’Neill Global Exchange conference last week.
In an interview, Clayton told CNBC that the classic definition of a security would be used to evaluate crypto assets and ICOs. If you are raising money from a centralized source for a project that people are investing in with the expectation of a return, that is an investment and a security.
Clayton also made it clear that the SEC was not going to change that definition just because of the new technologies: “I understand that there is a great deal of discussion about those crypto assets, but again we are not going to relax our rules based on the level of discussion. We need to know that the pricing is certain. We need to know that the assets are there. We need to know it’s going to function as our retail investors would expect those products to function.”
That definition of a security stems from the now-famous Howey decision, a 1946 case that went all the way to the Supreme Court. In that case, W.J. Howey owned large tracts of citrus groves in Florida and sold real estate contracts for some of the land to finance future developments. The purchaser of the land would lease it back to Howey, who would tend to the land and harvest the fruit. Howey promised significant profits.
Howey never filed a registration statement with the SEC, and the agency sued. The Supreme Court held that Howey was indeed offering an investment contract which “for purposes of the Securities Act means 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.”
That has been the definition of a security ever since.
The problem is that, when you are selling ICOs, it’s easy to conceive of offering a token that doesn’t fit the definition of a security.
Suppose you were selling golf club memberships using ICOs. There’s no expectation of a profit there.
Or suppose you were selling membership in a monthly book club, where the only expectation was to get discount books. There’s no expectation of a profit, either.
I would expect the SEC to say under what conditions an ICO would be considered a security.
The issue of whether alt-coins like ripple or ether are securities is a tougher question. If these coins have evolved so there is not an issuer or an organized third party behind them, then the determination becomes a lot murkier.
My guess: I wouldn’t be surprised if the SEC punted and allowed the issue to be litigated in the courts (there is an ongoing lawsuit already regarding ripple).
Where does this end? At some point, the SEC is going to stop the hand-holding and start the enforcement. They’re going to feel that, at least with ICOs, they have given enough guidance so that everyone who is issuing these coins will easily be able to tell if they are a security or not.
Even if the SEC does try to get a little clearer on the rules, it doesn’t resolve an additional regulatory issue. There is a patchwork of state regulations that control money transfers.
But that is an issue for another day.
William Hinman will appear on CNBC’s “Closing Bell” at 3 p.m. ET.