SEC chairman Jay Clayton made it clear: Use the “Howey Test” to determine if an ICO qualifies as a security.
What is the Howey Test and What’s It Got To Do With ICOs?
Established during a 1946 dispute over an orange grove, judges use the Howey Test to determine whether or not an investment contract qualifies as a security. If it does, then it’s subject to various SEC registration requirements meant to safeguard market conditions.
The Howey Test Questions
How do you apply the Howey Test? It consists of four questions.
- Did an entity invest money?
- Does the investment vehicle qualify as a “common enterprise” under SEC regulations?
- Do investors expect to profit from the investment?
- Does profitability rely on the seller’s efforts?
In his latest statement, Clayton defines a security as “an investment in a common venture, premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”
Can an ICO Start as a Security and Change Status?
By virtue of their nature, most (not all) initial coin offerings fall under the securities’ umbrella. However, an instrument’s status can change over time. Clayton confirmed: “The analysis of whether a digital asset is offered or sold as a security is not static.”
Remember, if people pool assets, but don’t expect the developers or sellers to “carry out managerial or entrepreneurial efforts,” then the project may not pass the Howey Test. For example, Ethereum isn’t a security because it’s too decentralized.
SEC Policing ICOs “Vigorously”
Clayton’s statement also made it clear that the Securities and Exchange Commission is vigilantly policing ICOs. He warned:
“[The commission will] continue to police these markets vigorously and recommend enforcement actions against those who conduct ICOs or engage in other actions relating to digital assets in violation of the federal securities laws. Those who invest their hard-earned money in opportunities that fall within the scope of the federal securities laws deserve the full protections afforded under those laws.”
For Clayton’s full statement, click here.
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