Crypto-law: Enforcement Actions And New Legislative Actions In The U.s. And Abroad
CRYPTO-LAW: ENFORCEMENT ACTIONS AND NEW LEGISLATIVE ACTIONS IN THE U.S. AND ABROAD
Unprecedented Enforcement Actions by the SEC
The pace of enforcement actions initiated by the SEC against cryptocurrency firms reached unprecedented levels last week with the filing of two significant lawsuits against Binance and Coinbase. In the case of Binance, the charges are more extensive, encompassing allegations of fund commingling and an artificial separation between Binance.com and Binance.us.
Both lawsuits share a commonality, namely, the accusation of listing numerous unregistered securities on their respective exchanges. While this aligns with the opinion of SEC Chairman Gensler, who frequently asserts that all crypto tokens should be treated as securities, it is important to note that this position lacks proper establishment.
The "Howey Test" and the Interpretation of Securities Regulations
It is primarily based on a broad interpretation of a 1946 Supreme Court case known as the "Howey Test”. Notoriously, the “Howey Test” consists of four key prongs:
- Investment of Money: The transaction involves the contribution of money or other valuable assets.
- Common Enterprise: The investors' fortunes are intertwined or pooled together, indicating a shared interest in the success of the venture.
- Expectation of Profit: Investors have a reasonable expectation of earning profits from the efforts of others, typically the promoters or third parties.
- Efforts of Others: The profits primarily result from the efforts, expertise, or managerial actions of others rather than the investors' own efforts.
If all four elements are met, the transaction is considered an investment contract and subject to securities regulations.
Unsettled Questions Surrounding Digital Tokens
Specifically, valid defenses have been raised regarding whether numerous digital tokens fulfill the third and fourth elements. With respect to the “expectations of profits”, Courts closely examine the nature of the investment and the promises made to investors regarding potential returns. The key is whether investors anticipate receiving profits primarily from the efforts of others rather than their own work or actions. Many digital tokens are issued by promoters and purchased by investors due to their anticipated utility within a platform, with profit being a secondary consequence. In the majority of these cases, this criterion is not satisfied in courts.
The Need for Legislative Clarification
With regard to the “effort of others”, courts consider whether the success of the investment relies on the expertise,skills, or efforts of individuals or entities with specialized knowledge. Clearly, the decentralization of multiple companies issuing digital tokens raise questions regarding the fulfillment of this prong. On this page, the famous 2018 speech of then SEC Corporate & Finance Director William Hinman explained that if the network where the token or coin is to function becomes sufficiently decentralized, the assets may not represent securities.
To sum up, the determination of whether digital tokens satisfy the "Howey Test" remains unsettled in the US federal courts, leaving room for further clarification.
In essence, it should be understood that this interpretation does not represent established law; rather, it reflects an assertive strategy pursued by the SEC, which appears to have declared a figurative war on the crypto industry in the US for political reasons.
The Long Road to Comprehensive Legislation
Asserting that the SEC is overstepping its authority does not equate to advocating leniency within the industry. It is essential to protect small investors from being deceived by token issuers who rely solely on hollow commitments and impressive documentation. Put plainly, these issues require regulation through the legislative process conducted by the US Congress, rather than being left to federal agencies' rulemaking procedures or, worse yet, enforcement actions.
A recent positive development is the “Digital Asset Market Structure Proposal'' jointly released by the House Financial Services Committee and by the House Committee on Agriculture. The key section provides clarity on the when a digital asset can be exempted from the securities laws: 1) the issuer’s total sales of the digital asset over the prior 12 months does not exceed $75 million; 2) a non-accredited investor’s purchases of the digital asset from the issuer over the prior 12 months are less than the greater of 5% of the purchaser’s annual income or 5% of their net worth; 3) the purchaser does not own more than 10% of the units of the digital asset after the completion of the transaction; and 4) the transaction does not involve equity or debt securities.
The Digital Asset Market Structure Proposal
Undoubtedly, this represents a significant stride in the right direction. However, it is crucial to acknowledge that this is currently just a proposal and far from being enacted as law. Considering the absence of consensus within the US Congress, it remains uncertain how much time will elapse before we witness the emergence of comprehensive legislation on this matter. Until then, the message being conveyed to other companies operating in the cryptocurrency industry is unequivocal and concerning. Many of these companies lack the financial resources to effectively combat broad accusations brought by the immensely powerful SEC. The underlying message is clear: consider relocating your business elsewhere. This trend is already underway, as demonstrated by Coinbase's launch of the "Coinbase International Exchange" in Bermuda and Gemini's application for a license in the United Arab Emirates.
Global Developments: Hong Kong and the EU
Hong Kong has recently taken a significant step towards fostering the growth of the crypto market by introducing its own comprehensive legislation. This groundbreaking move enables retail investors to participate directly in the dynamic world of crypto assets. Even more interestingly, the EU recently ratified the EU-Markets in Crypto-Assets (MiCA) regulations, which will enter a transitional period shortly. MICA aims at offering transparency and clarity by creating a distinctive regulatory framework within the European Union (EU) that specifically caters to cryptocurrency enterprises, providing enhanced understanding of the comprehensive guidelines for participants in the industry.
MiCA Regulations: A Unified Framework for Crypto-Asset Service Providers
MiCA brings forth a unified authorization system that applies across all EU member states for Crypto-Asset Service Providers (CASPs), which are defined those providing one of these services: Custody and administration of crypto-assets on behalf of third parties; Operation of a trading platform for crypto-assets; Exchange of crypto-assets for fiat currency; Exchange of one or more crypto-assets for another; Execution of orders for crypto-assets on behalf of third parties; Placing of crypto-assets; Reception and transmission of orders for crypto-assets; Advisory services related to crypto-assets; Issuance of crypto-assets, including initial coin offerings (ICOs); Participation in the creation of decentralized autonomous organizations (DAOs). As mentioned, CASPs that have obtained authorization in their respective countries of registration will gain the ability to offer their services to all nations within the European Union.
Business Opportunities in the European Market
Undoubtedly, this presents a significant business opportunity, even for existing US-based companies involved in crypto-services, as they can now establish a presence and assess their products or services within a well-established market such as the European one without the risk of being targeted by a powerful agency such as the US SEC. This holds even greater potential for players operating in an industry that already functions in a transitional manner, without the need for physical retail stores.
In conclusion, the recent enforcement actions by the SEC against cryptocurrency firms, particularly the lawsuits against Binance and Coinbase, have highlighted the need for clarity and comprehensive legislation in the crypto industry. The interpretation of the "Howey Test" and the determination of whether digital tokens satisfy the criteria remain unsettled, leaving room for further clarification in US federal courts. While the SEC's assertive strategy may reflect political motivations, it is crucial to protect investors from deceptive practices. The recently proposed "Digital Asset Market Structure Proposal" represents a step in the right direction, but its enactment as law is uncertain given the lack of consensus in Congress. Meanwhile, global developments, such as Hong Kong's comprehensive legislation and the EU's MiCA regulations, offer opportunities for businesses in the crypto industry to operate within well-defined regulatory frameworks. These developments emphasize the importance of adopting clear and unified legislation to foster the growth and innovation of cryptocurrencies while ensuring investor protection.