On September 8, 2022, in his remarks at the annual SEC Speaks conference, entitled Kennedy and Crypto, SEC Chair Gary Gensler declared:
Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities. Offers and sales of these thousands of crypto security tokens are covered under the securities laws.
Some tokens may not meet the definition of a security – what I’ll call crypto non-security tokens. These likely represent only a small number of tokens, even though they may represent a significant portion of the crypto market’s aggregate value.1
Unfortunately, Chair Gensler provided no guidance on how to tell a crypto security from a crypto non-security. Instead, he criticized those who have called for more clarity:
Some in the crypto industry have called for greater “guidance”2 with respect to crypto tokens.
For the past five years, though, the Commission has spoken with a pretty clear voice here: through the DAO Report, the Munchee Order, and dozens of Enforcement actions, all voted on by the Commission…
Not liking the message isn’t the same thing as not receiving it.
This remark feels like a cheap shot because it is one.3 It dismisses out of hand the concerns of crypto investors, entrepreneurs, intermediaries, and issuers who grapple daily – in good faith – with the question of whether the SEC or a court may find that certain digital assets are securities.
Instead, Gensler points us to the DAO Report and the Munchee matter, both involving an ICO. With a handful of exceptions, “the dozens of Enforcement actions” since have involved an ICO, such as the Kik, Telegram, and Ripple cases, or an offering fraud disguised as an ICO, such Centra Tech and Blockvest. In the latter case the technology, frankly, is irrelevant.4
An SEC action alleging a particular token is a security generally has serious, negative financial consequences for token holders. Gensler’s “guidance” appears to be caveat emptor, if you have purchased a token it’s probably a security, like we have told you so many times before.
LEGAL TOKENS
Gensler is right that there is no legal justification for treating capital raises differently under the federal securities laws just because investors’ interests are represented by tokens on a blockchain. But there are important ways in which blockchain technology does, in fact, complicate the securities law question. Gensler ignores this complexity altogether.
Gensler fails to address the fact that tokens that were securities when offered in an ICO may, over time, transform into non-securities, generally because token governance has become sufficiently decentralized such that purchasers no longer rely on the efforts of others for profits.5 Does the SEC intend to pursue actions against issuers where tokens were once but are no longer securities? Against intermediaries? Investors?
Furthermore, if outstanding SEC staff guidance such as the Framework for “Investment Contract” Analysis of Digital Assets, in Gensler’s view, is now invalid – and following that guidance may cause individuals or entities to fall afoul of the law – it is not enough for him to subtly distance himself from it. Rather, it is incumbent upon him to see to it that such guidance is withdrawn. If his view is, “once a security, always a security,” allowing staff guidance to the contrary to remain in effect poses a danger to well-meaning investors and market participants.
Gensler also fails to acknowledge that it’s not an either/or, i.e., either a token is a security or it is sufficiently decentralized to be a non-security. A conundrum unique to crypto arises from the fact that some purchasers may be motivated by investment, some by the desire to use or consume tokens, and some by both. In fact, many of the most well-known, widely held tokens fall somewhere on this complex spectrum, an issue not addressed under existing caselaw.
What is the standard in the mixed case where some token holders purchased for investment reasons, some for consumptive reasons, and some for both reasons? A federal district court asked the SEC this very question, just weeks ago, in its pending action against LBRY, Inc, at oral argument on the parties’ cross-motions for summary judgment, and the SEC did not have a clear answer.
As Gensler noted, it’s been more than five years since the DAO Report. In that time, crypto has become increasing mainstream, purchased by millions of retail investors whom the SEC can harm by its inaction; we have moved beyond the ICO paradigm to more complex sets of facts and circumstances; and, many tokens that may have been securities when first offered and sold now resemble BTC or ETH more and more every day.
The market’s message to the SEC is clear: There are still questions to be answered, “guidance” to be given. Not liking the message isn’t the same thing as not receiving it.
1 If this is a hint that Gensler believes ETH is not a security, after his recent waffling on the question, it would be nice if he said it out loud.
2 Gensler added the scare quotes to “guidance” in his speech, not me.
3 After all, in his speech, Gensler invoked Joe Kennedy, first Chairman of the SEC, who said, “No honest business need fear the SEC,” suggesting that those who disagree with him are not honest brokers, not John Kennedy who, in sending the first rocket ship to the moon, declared, “We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard, because that goal will serve to organize and measure the best of our energies and skills…” Admittedly, arguments made by some crypto enthusiasts are word salads sprinkled with “utility,” like so many bac-o-bits, in the face of an obvious security offering. But painting the whole industry with the same brush could be viewed as a gratuitous insult.
4 Irrelevant because it does not matter to the victim of a Ponzi whether the fraudster promised returns from discounted postal reply coupons or tokens.
5 This fact was acknowledged by the then director of the SEC’s Division of Corporation Finance, William Hinman, in his famous speech, Digital Asset Transactions: When Howey Met Gary (Plastic) and reinforced by the SEC’s Framework for “Investment Contract” Analysis of Digital Assets.
