SEC Declines Amnesty for Unregistered Crypto Enforcement

SEC Declines Amnesty for Unregistered Crypto Enforcement

The U.S. government does not like cryptocurrency and for US Taxpayers and entities that have violated the law, it can be a very uphill climb to get into compliance. A few years back, the Internal Revenue Service made it known they would not offer a stand-alone cryptocurrency amnesty program (although the 2022 update Form 14457 does specifically reference virtual currency). Now, the SEC makes it clear it is following the same roadmap by stating it will not offer a specific SEC amnesty program for cryptocurrency-related matters.

Is Crypto Reportable Investment Securities?

One of the main issues with cryptocurrency and the SEC is whether the cryptocurrency must be registered with the SEC (U.S. Securities and Exchange Commission) in the context of an ICO (Initial Coin Offering). In other words, does cryptocurrency qualify as securities under SEC law sufficient so that it must register.

As provided by the SEC

• • • Both the Commission and the federal courts frequently use the “investment contract” analysis to determine whether unique or novel instruments or arrangements, such as digital assets, are securities subject to the federal securities laws.

    • The U.S. Supreme Court’s Howey case and subsequent case law have found that an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.[5]  The so-called “Howey test” applies to any contract, scheme, or transaction, regardless of whether it has any of the characteristics of typical securities.[6]  The focus of the Howey analysis is not only on the form and terms of the instrument itself (in this case, the digital asset) but also on the circumstances surrounding the digital asset and the manner in which it is offered, sold, or resold (which includes secondary market sales).  Therefore, issuers and other persons and entities engaged in the marketing, offer, sale, resale, or distribution of any digital asset will need to analyze the relevant transactions to determine if the federal securities laws apply.

    • The federal securities laws require all offers and sales of securities, including those involving a digital asset, to either be registered under its provisions or to qualify for an exemption from registration.  The registration provisions require persons to disclose certain information to investors, and that information must be complete and not materially misleading.  This requirement for disclosure furthers the federal securities laws’ goal of providing investors with the information necessary to make informed investment decisions.  Among the information that must be disclosed is information relating to the essential managerial efforts that affect the success of the enterprise.[7]  This is true in the case of a corporation, for example, but also may be true for other types of enterprises regardless of their organizational structure or form.[8] 

    • Absent the disclosures required by law about those efforts and the progress and prospects of the enterprise, significant informational asymmetries may exist between the management and promoters of the enterprise on the one hand, and investors and prospective investors on the other hand.  The reduction of these information asymmetries through required disclosures protects investors and is one of the primary purposes of the federal securities laws. 

How the SEC Applies the Howey Test to Digital Assets 

As further provided by the SEC:

• • • In this guidance, we provide a framework for analyzing whether a digital asset is an investment contract and whether offers and sales of a digital asset are securities transactions.  As noted above, under the Howey test, an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.  Whether a particular digital asset at the time of its offer or sale satisfies the Howey test depends on the specific facts and circumstances.  We address each of the elements of the Howey test below. 

The Investment of Money

• • • The first prong of the Howey test is typically satisfied in an offer and sale of a digital asset because the digital asset is purchased or otherwise acquired in exchange for value, whether in the form of real (or fiat) currency, another digital asset, or other type of consideration.[9]

Common Enterprise

• • • Courts generally have analyzed a “common enterprise” as a distinct element of an investment contract.[10]  In evaluating digital assets, we have found that a “common enterprise” typically exists.[11]

Reasonable Expectation of Profits Derived from Efforts of Others

• • • Usually, the main issue in analyzing a digital asset under the Howey test is whether a purchaser has a reasonable expectation of profits (or other financial returns) derived from the efforts of others.  A purchaser may expect to realize a return through participating in distributions or through other methods of realizing appreciation on the asset, such as selling at a gain in a secondary market.  When a promoter, sponsor, or other third party (or affiliated group of third parties) (each, an “Active Participant” or “AP”) provides essential managerial efforts that affect the success of the enterprise, and investors reasonably expect to derive profit from those efforts, then this prong of the test is met.  Relevant to this inquiry is the “economic reality”[12] of the transaction and “what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect.”[13]  The inquiry, therefore, is an objective one, focused on the transaction itself and the manner in which the digital asset is offered and sold.   

What did the SEC Recently Say about Amnesty?

Gurbir Grewal (Director of Enforcement) provided the following statement:

• • • “Our message to them is not, ‘Register your product, and we’ll just ignore the billions you have under management in this crypto lending product and your violations of the securities laws. “

    • Our message is that we’ll view their conduct more favorably if they come in — such as what the remedies will look like, including penalties, and finding a path to complying with the securities laws”

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