framework for “investment contract” analysis of digital assets

See also Tcherepnin, 389 U.S. at 336 (“in searching for the meaning and scope of the word ‘security’ in the [Acts], form should be disregarded for substance and the emphasis should be on economic reality.”). For example, the design of the digital asset provides that its value will remain constant or even degrade over time, and, therefore, a reasonable purchaser would not be expected to hold the digital asset for extended periods as an investment. In applying the framework to digital assets, the SEC focuses on three main prongs. [9] The lack of monetary consideration for digital assets, such as those distributed via a so-called “bounty program” does not mean that the investment of money prong is not satisfied. The retailer continues to market its products to its existing customer base, advertises its digital asset payment method as part of those efforts, and may “reward” customers with digital assets based on product purchases. The digital asset is marketed, directly or indirectly, using any of the following: The expertise of an AP or its ability to build or grow the value of the network or digital asset. A digital asset should be analyzed to determine whether it has the characteristics of any product that meets the definition of “security” under the federal securities laws. The inquiry into whether a purchaser is relying on the efforts of others focuses on two key issues: Although no one of the following characteristics is necessarily determinative, the stronger their presence, the more likely it is that a purchaser of a digital asset is relying on the “efforts of others”: In evaluating whether a digital asset previously sold as a security should be reevaluated at the time of later offers or sales, there would be additional considerations as they relate to the “efforts of others,” including but not limited to: An evaluation of the digital asset should also consider whether there is a reasonable expectation of profits. Although no one of the following characteristics of use or consumption is necessarily determinative, the stronger their presence, the less likely the Howey test is met: Digital assets with these types of use or consumption characteristics are less likely to be investment contracts. FinHub's framework explains the staff's views on how the "investment contract" analysis… It is not an exhaustive treatment of the legal and regulatory issues relevant to conducting an analysis of whether a product is a security, including an investment contract analysis with respect to digital assets generally. Howey found that an “investment contract” exists where there is an investment of money in a common enterprise with a reasonable expectation that profits will be derived from others’ efforts. The distributed ledger network and digital asset are fully developed and operational. The Supreme Court has further explained that that the term security “embodies a flexible rather than a static principle” in order to meet the “variable schemes devised by those who seek the use of the money of others on the promise of profits.”  Id. [8]  Absent the disclosures required by law about those efforts and the progress and prospects of the enterprise, significant informational asymmetries may exist between the management and promoters of the enterprise on the one hand, and investors and prospective investors on the other hand. To address the more common implementations and applications of blockchain, tokens and cryptocurrencies, Division of Corporation Finance Staff announced the release of a "Framework for 'Investment Contract' Analysis of Digital Assets… The discussion above identifies some of the factors market participants should consider in assessing whether a digital asset is offered or sold as an investment contract and, therefore, is a security. For example, it is offered and purchased in quantities significantly greater than any likely user would reasonably need, or so small as to make actual use of the asset in the network impractical. [9], Courts generally have analyzed a “common enterprise” as a distinct element of an investment contract. This particularly would be the case where an AP promises further developmental efforts in order for the digital asset to attain or grow in value. Any economic benefit that may be derived from appreciation in the value of the digital asset is incidental to obtaining the right to use it for its intended functionality. The digital assets’ creation and structure is designed and implemented to meet the needs of its users, rather than to feed speculation as to its value or development of its network. In this guidance, we provide a framework for analyzing whether a digital asset … A digital asset should be analyzed to determine whether it has the characteristics of any product that meets the definition of “security” under the federal securities laws. What is material depends upon the nature and structure of the issuer’s particular network and circumstances. Where the network or the digital asset is still in development and the network or digital asset is not fully functional at the time of the offer or sale, purchasers would reasonably expect an AP to further develop the functionality of the network or digital asset (directly or indirectly). Howey Co. and subsequent case law. Does the purchaser reasonably expect to rely on the efforts of an AP? Managerial and entrepreneurial efforts typically are characterized as involving expertise and decision-making that impacts the success of the business or enterprise through the application of skill and judgment. That a scheme assigns “nominal or limited responsibilities to the [investor] does not negate the existence of an investment contract.”  SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 483 n.15 (5th Cir. denied, 414 U.S. 821, 94 S. Ct. 117, 38 L. Ed. This requirement for disclosure furthers the federal securities laws’ goal of providing investors with the information necessary to make informed investment decisions. The federal securities laws require all offers and sales of securities, including those involving a digital asset, to either be registered under its provisions or to qualify for an exemption from registration. No AP has access to material, non-public information or could otherwise be deemed to hold material inside information about the digital asset. Profits can be, among other things, capital appreciation resulting from the development of the initial investment or business enterprise or a participation in earnings resulting from the use of purchasers' funds. The second piece of guidance came in the form of a “Framework for ‘Investment Contract’ Analysis of Digital Assets” that is intended to serve as “an analytical tool to help market participants … Whether holders are then able to use the digital asset for its intended functionality, such as to acquire goods and services on or through the network or platform. This also can be the case where the digital asset gives the holder rights to dividends or distributions. Community Development Financial Institutions Fund, Stimulus Package Reverses IRS’s Position on Deductibility of PPP Expenses and Other Loan Forgiveness Issues, Nasdaq Proposes New Listing Rules to Advance Board Diversity: Comply or Explain, More Disclosure Modernization: SEC Adopts Significant Amendments to Financial Disclosure Rules, SEC Eases Limits and Rules on Private Offerings, SEC Proposes Conditional Exemption for "Finders" Involved in Capital Raising, Ohio Adopts Protections for Ohio Businesses from Coronavirus - Related Lawsuits, SEC Scales Back Financial Disclosures for Business Combinations, State of Ohio Issues Urgent Health Advisory and Partial Rescission of “Stay at Home” Order, SEC Adopts Temporary Rules to Expedite Regulation Crowdfunding Offerings Amid COVID-19 Pandemic, Treasury Releases PPP Loan Forgiveness Application. Howey Co., 328 U.S. 293 (1946) (“Howey“). Prospects for appreciation in the value of the digital asset are limited. Whether the network on which the digital asset is to function operates in such a manner that purchasers would no longer reasonably expect an AP to carry out essential managerial or entrepreneurial efforts. The information contained within another site that is linked to or from the Blog are beyond the control of the individual blogger or KMK and do not convey approval, support, or any relationship to any site or organization. First, in determining whether there is a reliance on the efforts of others, the SEC analyzes whether a purchaser of the assets is reasonably expecting to rely on the efforts of a promoter, sponsor, or other third party and whether such efforts are “essential managerial efforts”. at 299. See In re Tomahawk Exploration LLC, Securities Act Rel. 1994) (discussing horizontal commonality as “the tying of each individual investor’s fortunes to the fortunes of the other investors by the pooling of assets, usually combined with the pro-rata distribution of profits” and two variants of vertical commonality, which focus “on the relationship between the promoter and the body of investors”). As noted above, under the Howey test, an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. On April 3, 2019, the SEC’s Strategic Hub for Innovation and Financial Technology (“FinHub”) 1 published a framework for analyzing whether a digital asset is offered and sold as an investment contract and, therefore, is a security (the “Framework… Of quantities indicative of a user of the proceeds from the sale of the issuer s! 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