Hidden Problems With the SEC’s “Crypto-Security”
This article is the fifth in a multi-part series in which we explain how the SEC has structured its anti-cryptocurrency campaign, why the SEC has over-reached its regulatory authority in attacking the creators of digital tokens and cryptocurrencies, and how to address the SEC’s actions in this area.
The SEC treats a digital token, including one that is not a security in any obvious way, as if it were a security. The result is that the original sale or resale of a cryptocurrency or other related blockchain product is considered unlawful if not registered with the SEC.
This treatment is based on the fact that a digital token:
- is invisible and intangible;
- lacks inherent value;
- can provide a buyer with one or more rights; and
- can be bought as an investment.
These facts are not debatable, but the question is whether they are conditions that are sufficient to make something — like a digital token — a “security” under the applicable federal laws. In this article, we show why these are not sufficient conditions and why this causes significant, hidden problems for the SEC’s enforcement program in this area, particularly, its misapplication of the Howey case to digital tokens and cryptocurrencies.
What Is a “Security?”
Among other things, a security is a concept. Like other concepts, it isn’t necessarily simple or intuitive. While one might recognize that a share of stock is a security, that does not mean one understands why it is a security.
This difference between recognizing a standard security, such as a share of stock, and understanding what makes it a security has enabled the SEC to convince some attorneys and judges that what the SEC calls “digital assets” — digital tokens on a blockchain, including cryptocurrencies — are securities under the catch-all category of “investment contract,” even if they are not securities. We explain how this came about below. We will first describe several important properties of a security and then discuss why the SEC is wrong in claiming that most digital assets are investment contract-type securities. We’ll refer to the SEC’s concept as a “crypto-security” for convenience.
A “Security” Is Not Necessarily Secure. The term “security” is misleading. It is not necessarily or always “secure,” and this is one reason why the product called a security is pervasively regulated.
A “Security” Is Invisible. You might think of a security as an “invisible person” whom you can only see when wrapped in something that shows the outline of the individual’s body and head. In the case of the security, this wrapping has long taken the form of paper with writing that is characterized as a certificate, such as a bond certificate or stock certificate. Sometimes, but not always, units of the security are “tied” to the certificate, as when the certificate is a bearer bond. Like currency, one can transfer “title” (another legal construct) to the bearer bond instrument by giving possession of the certificate to another. Other certificates, like stock certificates, may be lost by the owner, but the same tokens of the security can be placed into a new replacement certificate (because stock ownership is tracked by a corporation or by a corporation’s transfer agent).
A “Security” Is a Product. A security is a “product” that a business enterprise creates, by resolution of the enterprise’s governing board, and sells to a buyer. The buyer then holds as evidence of the buyer’s right to some portion of the business enterprise’s assets. The business enterprise uses the proceeds of the security sale to finance its operations.
A security differs, however, from a business operations-made product, such as a bicycle, which a business enterprise manufactures and sells to a buyer, hopefully at a profit, that the buyer can then use for travel or exercise but which gives the buyer no right to the business enterprise’s assets. The business enterprise also uses the proceeds of product sales to finance its operations.
A “Security” Is a Set of Rights to a Business Enterprise’s Assets. The sole utility of a security is as a type of investment in which the buyer hopes to recover the purchase price (or principal) and extra money in addition to the principal. The extra money may be obtained as income (interest or dividends) directly from the business enterprise or as a gain from a sale of the security on a secondary market that pays the buyer more than the buyer paid for the security.
The Word “Security” Has Two Meanings. The term “security” is ambiguous: it can mean a type of security, for example, a debt security with its own CUSIP number or a particular token of that type of security, such as a specific debt certificate with its own certificate number.
Other Terms Are Needed to Understand What Makes a “Security.” To understand what makes something a security, we include a brief overview of what an “entity” is, what an “accounting entity” is, and what kind of accounting entity can create a security. Then we discuss “transaction,” how a contract fits within a transaction, and the “performance obligations” a contract creates for the seller and buyer — the parties to the contract. With this overview, we then turn our attention to the contract of investment. This is the contract by which an entity creates and sells a set of rights, including a right to the entity’s assets — the security — to the buyer for money. Every security is sold utilizing this contract.
What Is an “Entity?”
An Entity Is an Organization of One or More Individuals. An entity is an organization of one or more individuals and is recognized as a unit of action, identified typically by a name, logo (or “face”), and location of operations.
An Entity Enters Into Transactions. A transaction is a set of actions and interactions between or among individuals or entities (parties) in which a contract is formed, contract obligations are performed, and the contract “settles” or “closes” when all arranged transfers of value have occurred. More generally, transactions can involve one party’s transfer of value to another party.
There Are Three Major Types of Transactions. The three types of transactions are (1) buy-sell; (2) lease-rent; and (3) loan-borrow. A transaction for services is a buy-sell transaction. A transaction for a good or space, however, varies depending on whether the owner of the good or space transfers “title” to, or only possession of, the good (personal property) or real property (land or building or both). If the seller transfers title to the personal or real property, the transaction is typically a buy-sell transaction. If the seller transfers only possession, it is a lease-rent transaction. A loan-borrow transaction (of money or a security) is, however, a hybrid because the “title” to the specific units loaned is transferred to the borrower, but the borrower must return different units back to the lender as in a lease-rent transaction. In a buy-sell transaction, the seller performs by providing a good, service, or good and service to the buyer, and the buyer performs by paying the seller. (The performances can be “simultaneous,” as happens at a point-of-sale cash register in a retail store, or staggered, as happens in an online store when the buyer pays first and the seller delivers later.)
A Transacting Entity Is, by Definition, an Accounting Entity. An accounting entity is an entity that enters into transactions in its own name with other entities and individuals. These transactions can be recorded, stored, organized, and combined to provide financial information, including the financial status (or position) of the entity (assets, liabilities, and net ownership) at a point in time, and the financial performance (profits and losses) over a period of time, for use inside and, if needed or required, outside the entity. Because the sale of a security is a transaction, the creator-seller of a security must be an accounting entity.
An Accounting Entity Can, but Need Not, Be a Legal Entity. A legal entity is an entity that the state authorizes by law. The entity files an organizing document submitted by its founders to the appropriate state agency (often the State Corporation Commission), such as articles of incorporation (for a corporation) or articles of organization (for a limited liability company). The corporation can be for-profit or not-for-profit (and therefore, non-stock), and the limited liability company can be a single-member LLC or have multiple members (it is possible to have a corporation with a sole stockholder as well). The organization commences its legal existence on the date of the filing in compliance with state law.
A non-legal accounting entity is a transacting entity, the founder(s) of which has/have not registered with the state pursuant to state law. Examples include a “sole-proprietorship,” where a single individual owns and operates as a business enterprise. A second example is a general “partnership,” in which two or more individuals or entities (or individuals and entities) own and operate; this may be a business enterprise or it could be an association of two or more individuals or entities not operating as a business enterprise. The sole proprietorship comes into existence with the commencement of activity, but the partnership or association does so with an oral (or written) agreement or the commencement of activity. A partnership is not formed by a filing with the state, but partnership statements are often permitted to be filed with the State Corporation Commission. If a partnership’s activity begins before (or continues without) a formalized agreement, then the relevant state law of partnership will supply the terms of the agreement.
What Is a “Contract of Investment?”
Any Entity Needs Money to Transact. An entity always needs money to operate because it engages in multiple transactions. The money obtained through initial financing transactions is used for investment into non-current assets (assets that last over one year), such as real property (land and buildings), equipment (machines, automobiles, and business furniture), as working capital to hire and compensate employees, pay rent, and to purchase inventory (raw materials for a manufacturer or finished goods for a retailer). The entity will also use the money to pay for expenses incurred in marketing and selling its goods or services.
Any Accounting Entity Uses Financing Transactions for Money. Every entity must first finance its operations through financing transactions either with the owner(s), outsider(s), or both owners and outsiders. For the non-profit enterprise, initial financing typically involves soliciting and obtaining donations or gifts.
An Accounting Entity Must Be Owned to Be a Business Enterprise. An entity may be owned or unowned; if it is owned and exists to generate profits for its owner(s) through sales transactions (of goods or services) to consumers, it is a for-profit or business enterprise. If an entity is unowned and exists to provide services to the public through interactions or transactions with the public, it is a non-profit or governmental enterprise.
Only a Business Enterprise Can Create, Offer, and Sell an Equity Security. An initial financing transaction of a business enterprise typically requires offering, creating, and selling a security, which is a contract of investment (a business enterprise’s borrowing from a bank or vendor does not create a security). A contract of investment requires the buyer to pay money (called capital) to the business enterprise in exchange for a set of rights, measured in units of currency or ownership, which provides the buyer with rights, including rights to the business enterprise’s assets.
The Seller and Buyer of a Security Have Different Incentives. The incentive of the business enterprise in creating (issuing), offering, and selling a security is to raise capital from the buyer. The incentive of the buyer in paying for a security is to invest the purchase price (principal) with the hope of receiving, at the exit-of-investment date, (1) a return of the (full) purchase price paid for the security; and (2) a (known or unknown percentage) return on the purchase price. If the security holder does not receive a return of the full purchase price, it will be a loss on the investment.
The Security Seller’s Assets. As an accounting entity, the business enterprise either owns or holds (possesses through leasing) the assets. If the business enterprise is a legal entity, such as a for-profit business corporation or limited liability company, the entity owns the assets. If it is not a legal entity, the proprietor or partners own the assets directly. The business enterprise’s assets include not only the amount of contributed capital, but money (cash), receivables, and other assets obtained and characterized as revenue from sales of operating goods or services, gains from sales of investments, or money received from new financing transactions.
The Set of Rights. There are two basic categories of rights to the assets of the business enterprise: debt-type rights-to-assets and equity-type rights-to-assets. If the sell-buy transaction creates for the seller an obligation to repay to the buyer the purchase price or principal (as occurs in a loan-borrow transaction), typically with interest, the set of rights aligns with a debt-type security. The units of a debt instrument are typically in units of currency, such as U.S. dollars. A debt security usually, but not necessarily, has a definite duration, ending on a maturity date.
If, however, the buyer receives a portion of ownership in the business enterprise and shares in the earnings of the enterprise and the increased value of the enterprise is treated as a capital asset itself, then the security is more of an equity-type security. Owners of a legal entity are indirect owners of the assets: they own the entity, while the entity owns the assets — including the portion of assets classified as contributed capital and retained earnings (earned capital).
The security can be identified by the rights that the business enterprise gives to the buyer and the name it gives to the security. If, however, the rights are an unusual hybrid of debt and equity, unnamed, or result from multiple contracts, then they will fall into the category of “investment contract.” The “investment contract” is simply a catch-all category for a “non-standard” set of rights to the business enterprise’s assets. This category (listed in the definition of “security” in the Securities Act of 1933 and the Securities Exchange Act of 1934) has come to include certain securities originally structured not to be securities to avoid application of the federal (and state) securities laws.
One way to think of the set of rights characterized as an “investment contract” is to consider a continuum that has, at one end, “pure” debt-type rights to assets, and on the other end, “pure” equity-type rights to assets. Within this continuum exist innumerable possible hybrids. For example, the business enterprise’s security may give the security holder a guaranteed minimum interest payment, a percentage of the enterprise’s annual earnings, and a put option that enables the security holder to force the enterprise to buy back the security at a fixed or determinable price on a certain date, after an identified date, or within a specified window of time. Because such a hybrid security is not standard, it would fall within the catch-all category of the “investment contract.”
Rights to Business Enterprise’s Assets. If the business enterprise owns the assets, which is the case for a legal entity, then the securitybuyer and holder’s rights to the entity’s assets are indirect. In the case of a debt security, however it is structured, the entity must pay cash that includes principal and interest over some time or on the maturity date. If the entity fails to make this total payment, the debt-holder can bring legal action to obtain payment from the entity’s assets. The equity security gives the securitybuyer and holder an ownership interest in the entity and, therefore, the entity’s assets.
Evidence of the Security. The security (or set of rights) can be evidenced by a single instrument, a set of instruments, oral representations, or a combination of instruments and oral representations.
Source and Specifics of the Set of Rights. The source of the rights may be the state business law (corporation law or LLC law), if the business enterprise is a legal entity, or a separate single contract or set of contracts between the business enterprise and buyer, or both.
Realizing Returns. The debtholder’s return of and return on the purchase price are typically fixed by amounts and dates at the time the security is created and sold (“determined”), or capable of being determined after the date of creation and sale (“determinable”). The return of the purchase price is called the repayment of principal, and the return on the principal is called interest. The debtholder may receive all of this total from the business enterprise or some amount upon resale of the debt security to another buyer. The resale price depends on a number of factors, including the market interest rate and the structure and payments made on the security as of the date of resale.
The equityholder’s return of and return on the purchase price can occur in one of two ways: by reselling the security back to the business enterprise, which is less common, or by selling the security to another individual or entity. If the business entity is “publicly traded” — that is, if a percentage of the stock issued and outstanding is traded on a national securities exchange (e.g., the NYSE Stock Exchange or the Nasdaq over-the-counter market), the buyer will likely be someone unknown to the reseller. If the company is not publicly traded, the equityholder who owns less than 50% of the total stock issued and outstanding may have difficulty recovering the return of and return on the purchase price. At worst, the stockholder can be a victim of minority-shareholder oppression and expropriation.
What Is “Registration” of a Security?
If a business enterprise intends to offer and sell its securities to the public, the Securities Act of 1933 requires that such tokens first be “registered.” This requires the business enterprise to submit a prospectus and other documents as exhibits to the SEC. The prospectus includes a management discussion and analysis (“MD&A”) describing the business enterprise, its operations, and its market (among other things), financial statements, which include balance sheets and income statements, and notes to the financial statements.
Why Is Registration Needed? Securities are unlike concrete products: they are invisible and consist, in effect, of implicit promises and paper. In this respect, they are similar to insurance products, which are heavily regulated at the state level in the U.S.
What Does Registration Do for a Security Buyer? Registration provides relevant information about the present and future value of a business enterprise as a capital asset and, therefore, about its potential value from a lender’s or owner’s perspective. The SEC receives and critiques the information and evaluates whether the information is adequate in scope and depth to allow the registration to become effective. The submissions are publicly available, as are the final effective documents.
When the SEC declares a registration “effective,” the specific tokens of the security to be offered for sale can be sold. Those specific securities are now “registered” because (1) the issuer that created the securities for sale filed the requisite documents with the SEC; (2) the SEC has made those documents available to potential buyers of the securities; and (3) the potential buyers can read and review historical business and financial information about the issuer to make an informed investment decision. That informed investment decision will answer for the potential buyer the questions (1) whether the price for the security is too high in the view of the buyer; and, if not, (2) whether the buyer anticipates that the security will likely increase in value as a consequence of the business enterprise’s future financial performance.
Financial Statements Are Critical to a Business Enterprise’s Value. Imagine that a business enterprise is a money tree that generates cash instead of fruit or nuts. If observers of the tree anticipate that the tree will generate increasing amounts of cash in the future, the value of the tree on the investment market, whether debt or equity — ownership of a portion of the tree, as represented by an equity security — will likely increase. Anticipation of the tree’s increased “cash-fruitfulness” is a function, in part, of the quality and integrity of its management and the history of the size of the tree as revealed by its financial position and financial leverage, as well as its history of financial performance, namely, its history of profits and losses. This information is contained in the tree’s (or business enterprise’s) financial statements and notes to financial statements. If they are audited, as registration requires, the risk that the financial statements contain material misrepresentations may be reduced.
An Overlooked Function of Registration. Well understood but seldom mentioned is the function of the registration statement as evidence usable if the business enterprise is alleged to have made material misrepresentations in its financial statements or other documents filed with the SEC. The registration rules and processes are designed, in part, to commit the business enterprise to make, in writing, statements that could and likely would impact the value of any security that it offers and sells to the public.
What Does Registration Not Do for a Security Buyer? Registration provides information to the potential buyer of the current financial position and recent financial performance that the business enterprise publishes through the medium of the SEC. As is always the case, information can faithfully or fraudulently represent reality, present, and past. As noted, a security is the invisible set of rights that a business enterprise transfers to a buyer, and those rights include access to the business enterprise’s assets. But a buyer cannot often “see” the business enterprise, its managers, its collection of assets, its title or other rights to that collection of assets, or its operations. A fundamental principle is that the buyer of a security, like every other buyer of anything, must beware of being defrauded — caveat emptor. If defrauded, it is often difficult (and expensive) to recover even the purchase price.
In 1995, through the Private Securities Litigation Reform Act, Congress made recoveries for losses from alleged securities fraud much more difficult for investors to obtain. Although the SEC continuously touts its so-called investor protection program, until 2020, it did not consider itself obligated to return to security-buyers amounts it had recovered as “disgorgement” from defrauding business enterprises and individuals. This position only changed because the Supreme Court of the United States ruled that the SEC was indeed obligated to refund recovered loss amounts to the investors rather than deposit those amounts directly into the U.S. Treasury.
The security holder’s indirect rights to the enterprise’s assets are no better or greater than the enterprise’s rights to those assets and no greater than the value of those assets. The amounts by which those assets increase (through sales, interest earned, gains, and so on) and decrease (through costs of producing and selling goods and services) determine whether the total assets and the relative growth, non-growth, or decline in financial performance will increase, keep stable, or decrease the value of the business enterprise as a capital asset.
In sum, the business enterprise that creates a security — the issuer — registers the security with the SEC, and thereby becomes a “registrant,” so that prospective buyers of the security have information about the present financial condition and prospective performance of the enterprise. This information assists the investor in deciding whether the price at which the enterprise is selling the security is about right or is perhaps under- or over-valued.
What Test Determines Whether a Set of Rights Is an “Investment Contract?”
The U.S. Supreme Court’s opinion in SEC v. W. J. Howey Co., 328 U.S. 293 (1946) sets out a test to determine whether a contract is one of investment by which an enterprise indirectly transfers a set of rights to its assets to the buyer. Prior to this case, the appellate courts had dealt with a string of cases involving transactions designed to avoid application of the Securities Act of 1933 (or the Securities Exchange Act of 1934) to sales of what the SEC believed to be securities. Many of these involved the sale of what was, in effect, a business-within-a business. In Howey, the outer business was a commercial orange grove, and the business within that business was a portion of the orange grove — an orange grove (the “micro-grove business”) within the orange grove (the “macro-grove business”).
The structure of the contract of sale (or investment) in Howey made the game of find-the-security especially difficult. First, the sellers of the micro-grove businesses separated the orchard business into two parts: (1) orange grove land in Florida — the core capital asset — which W. J. Howey Co. (“WJH”) owned and which it sold, in unit parcels, to investors; and (2) business services on that land (and other capital equipment), for which another corporation, Howey-in-the-Hills Service, Inc. (“HIH”), provided services including planting, fertilizing, pruning, dusting, spraying, watering, and maintaining the orange trees and harvesting, marketing, selling, and accounting for the expenses of and revenue and profits from producing and selling the fruit. The business-service contract required the owner of each grove parcel to lease and provide exclusive possession of the parcel to HIH.
By segregating the micro-grove businesses into two parts, the capital assets (the parcels of grove land) and the business services concerning the land, the sellers required investors to enter into two contracts and thereby separated the right to the capital assets (the land) from the right to the resulting operating assets, namely, the earnings (or losses).
Even if one combined the separated rights to the assets, the “business enterprise” that generated the resulting assets from operations (the cash or receivables from sales of oranges) was unnamed and, of course, invisible. The problem was how could a business enterprise that seemingly did not exist issue financial statements and register a security evidenced only by a land sales contract, a warranty deed to a parcel of land within an orange grove, and a contract for services?
The SEC brought an enforcement action alleging that the sellers had sold unregistered securities (investment contracts) in violation of the registration provisions of the Securities Act. Both the U.S. District Court and the U.S. Court of Appeals ruled that the sellers had not sold a “security.” The sellers’ “transaction architecture” had successfully hidden both the security and the nameless business enterprise that issued the security.
The “Investment Contract” Can Capture the Well-Hidden Security. The U.S. Supreme Court, however, disagreed and reversed the two lower court rulings. The question the Court faced was “whether, under the circumstances, the land sales contract, the warranty deed, and the service contract together constitute an ‘investment contract’ within the meaning of [Securities Act] § 2(1).” Howey, 328 U.S. at 297. The Court held that the contract of investment through which the set of rights to the business enterprise’s assets flowed — in this case, cash distributions of net income in the form of dividends — was critical in finding the security. An “investment contract” is (1) a “contract, transaction, or scheme”; in which (2) the offeree “is led to expect profits solely from the efforts of the promoter or a third party”; (3) the expectation of profits prompts the offeree “[to] invest . . . money in a common enterprise”; and (4) the “shares in the enterprise” exist whether “evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.” Id. at 299 (emphasis added).
The investors have an “opportunity to contribute money and to share in the profits of a large citrus fruit enterprise” that is “partly owned by respondents.” The investors’ ownership — their “respective shares in this enterprise” — “are evidenced by land sales contracts and warranty deeds,” which, as the Court noted, “serve as a convenient method of determining the investors’ allocable share of the profits.” Id. at 300 (emphasis added). If investors “are to achieve their paramount aim of a return on their investments,” a managed “common enterprise” with employees and equipment is “essential.” Id. (emphasis added). The Court applied its new test to the facts of the matter and concluded that “all the elements of a profit-seeking business venture are present here.” 328 U.S. at 200 (emphasis added).
The “Common Enterprise” Requirement Left Confusion. Ever since the opinion was published, the SEC, private litigants, and courts have used the Howey test to determine if something invisible, for which one must pay, and that might increase in value, is a non-standard security within the catch-all term, “investment contract.” Unfortunately, in applying the critical requirement of a “common enterprise,” courts focused on the meaning of the adjective “common” at the expense of the much more important noun “enterprise.” This confusion has resulted in a line of cases that created and applied “integration tests” that looked to the relationships of parties to determine whether the requirement of “common” is satisfied; they do not identify the enterprise that would and should register the security at issue and determine whether investors had capitalized that enterprise. This has created what we call “the problem of finding the possible registrant.”
The Howey “Enterprise” Caused the Confusion. We believe that the courts’ focus on the adjective “common” reflects confusion about the enterprise and this confusion arises from the fact that the for-profit enterprise to which the Court in Howey referred was a business that was separate from WJH and HIH. It was an unnamed, non-legal, accounting entity that WJH, HIH, and the investors jointly created and owned as “a profit-seeking business venture.” As noted, the architects of the transaction in Howey (who almost succeeded in avoiding the Securities Act) deliberately partitioned the business enterprise’s assets and the investors’ rights to those assets in two, using two seemingly separate contracts. One contract provided investors the right to the capital asset of the land, while the other contract provided investors with business services and the right to the enterprise’s earned assets — cash.
This new enterprise, owned in common by the two corporations and the outside investors, provided capital and, based on their percentage of land ownership, the investors shared proportionately in the earnings and profits from sales of the oranges produced by the entire grove. Although unnamed, this common business enterprise could and had to create financial statements — if for no other reason than to determine quarterly or annual profits, losses, and distributions. “It” should have filed a registration statement that would have included those financial statements as a limited partnership, perhaps as “John Doe, L.P.,” with HIH acting as general partner and WJH and the other investors acting as limited partners.
What Is the SEC’S “Crypto-Security?”
In the area of digital tokens and cryptocurrencies, the SEC has relied on the confusion around the “common enterprise” prong of Howey and the consequential problem of finding the possible registrant to expand the meaning of “investment contract” by introducing an untenable conception of an enterprise. The result is the so far successful, if unlawful, expansion of its statutorily limited jurisdiction.
The SEC’s new conception of enterprise ignores the requirements that the common enterprise be (1) a for-profit business; (2) the transferor of sets of rights to its assets, including the proportions of assets classified as contributed capital and earned capital, to its investors; (3) an accounting entity that can issue financial statements; and (4) a possible registrant and, therefore, the filer of its financial statements. By ignoring these requirements, the SEC has also ignored the very function of registration, which is to give those who may buy a security information about the value of that security that derives from the financial condition and performance of its creator — the issuer.
In order to extend its jurisdiction to “enforce” laws that are limited to only a genuine security, the SEC has studiously avoided defining the “enterprise” in its cryptocurrency and utility token (digital asset) enforcement cases. A review of the cases the SEC has filed, however, reveals that the loosely identified “enterprise” in those cases is nothing more than a project to build an online platform on which one can use cryptocurrencies or utility tokens. The digital tokens themselves give their buyers no rights to (1) any assets of the project used to build the platform; (2) the platform itself, whether completed or not; or (3) revenues, earnings, or profits that the platform — if owned — may generate for its true owner. The digital tokens certainly do not provide their holders with any direct or indirect rights to the assets of the producer of the tokens. Such a producer already has its own capital structure, with its own debtholders and shareholders.
As demonstrated, the SEC’s cryptocurrency suppression program should, ultimately, fail in court when judges squarely confront the fact that the SEC has built its program on a foundation of sand. This, of course, requires litigants to properly frame the issue so that the courts possess the requisite context to analyze the crypto-securities that the SEC claims should be registered under the Securities Act. When litigants do so, courts will note that (unless the digital tokens are in fact designed to confer such rights), the digital tokens do not confer rights to the assets or revenue of any business enterprise, formal or informal. Accordingly, they are not securities, and the purposes for registration under the securities laws fail to apply.
Of course, none of this is to say that digital tokens and cryptocurrencies may not be regulated by anyone, nor that fraudulent activities in the sale or marketing of such tokens are immune from prosecution — that is not the case. This discussion only explains that the SEC has strayed beyond its jurisdictional remit in claiming to be the primary regulator of all “digital assets” as it is currently doing. The SEC’s program is not stopping fraud, or at least is not “only” stopping fraud. Rather, the SEC is actively interfering in the development of a new industry and imposing inapplicable regulatory requirements to force digital token producers to either change their business model or cease doing business. To us, this seems rather far afield of the SEC’s mission, as delineated in its enabling statutes.