Did the SEC Just Throw Away the Howey Test?

The following is a post by Andrew J. Chapin, CEO of Benja, that was originally posted on Medium on 8/29/2017.

The U.S. Securities and Exchange Commission (SEC) has been quiet since it shared its Report of Investigation on the DAO Token in late-July. Until yesterday, that is.

The SEC released a post titled Investor Alert: Public Companies Making ICO-Related Claims. Because I shared our experience with the SEC at benjaCoin (The SEC Called About Our ICO, I Answered), I woke up to a number of e-mails asking for my take. I’m answering here.

The first thing to know: there is great news in here.

When I spoke with the SEC representative in late-July, one of my big takeaways was that the SEC recognized that not all ICO events or token issuances are securities. I was lead to believe they would not be painting with broad strokes. The Investor Alert post reinforced that in the first paragraph:

Developers, businesses, and individuals increasingly are using ICOs — also called coin or token launches or sales — to raise capital. There has been media attention regarding this form of capital raising. While these activities may provide fair and lawful investment opportunities …

(Emphasis is mine)

One key takeaway, of course, is the SEC stance has not changed, and they are not placing one single label on all ICO events or token issuances. That’s a win.

There’s another big takeaway, however, and it lies in use of the word “investment.” 

Not to get all 7th-grade-essay on you, but a definition of investment is “the action or process of investing money for profit.” This directly conflicts with something the SEC previously shared, that the Howey Test was to be the guideline for judging whether a token is at risk of being labelled a security.

Under the Howey Test, a transaction of a security (or investment contract) if:

  1. It is an investment of money

  2. There is an expectation of profits from the investment

  3. The investment of money is in a common enterprise

  4. Any profit comes from the efforts of a promoter or third party

The second bullet is the one that I believe to be most important. Many legal and finance professionals who I’ve spoken to agree. In saying that ICO events or token issuances “may provide fair and lawful investment opportunities,” the SEC seems to have opened the door a little: are they now saying a token issuance which fails the Howey Test is possibly acceptable?

With benjaCoin, we’ve been clear that our token sale is to be treated as a pre-order of advertising inventory for the Benja ad network, and not as a security or investment. That, I believed, was to be one of the few “easy pass” situations when it came to the Howey Test.

It appears the SEC did one of two things: they made a poor word choice in their Investor Bulletin, or they’re signaling that the Howey Test isn’t to be treated as black and white as I once thought.

I’ve reached out for comment and will update this post if I hear back.

Otherwise, the Investor Bulletin is standard SEC warning stuff: some small cap(/penny) stocks are using ICO activity to drum up interest in their “business,” watch out for pump and dump schemes and market manipulation, be weary of trading recently-suspended stock, and beware of companies with no real business operations. Important stuff, but nothing groundbreaking.

I encourage anybody with questions about the SEC and token issuances — whether you’re running an ICO yourself or thinking of investing, whether you’re an American citizen or not — to reach out to a lawyer. The advice posted here is not to be considered legal advice of any kind. This is simply one man’s personal opinion about items the SEC has shared.