The SEC has now deemed 68 cryptocurrencies securities, and it’s not about to stop. The commission has hinted for years at considering nearly every cryptocurrency a security, except for Bitcoin. It has recently re-iterated that stance as part of its intensifying crusade against the crypto industry.
To recap: the SEC deems most cryptocurrencies unregistered securities that defy the law, except for Bitcoin. According to the Commission, Bitcoin is a commodity. Therefore, its regulation is under the purview of the CFTC and not the SEC.
How Does the SEC Define Securities?
How does the SEC determine whether an asset, digital or otherwise, is a commodity or security? The legal basis of the SEC’s current stance on the crypto industry is a 1946 Supreme Court ruling in the W.J. Howey Co. case.
The said case created the Howey Test, which authorities currently apply to assets to determine whether they are securities.
According to the Howey Test, an asset is a security if:
- It involves monetary investment.
- The investor invests expecting a profit.
- A common enterprise forms the basis of the investment.
- Profits result from the efforts of others.
Many cryptocurrencies started with massive pre-mines. Most have well-defined and known corporate entities behind them. The SEC deems these entities as the profit-producing motors of the enterprises the crypto securities support. Some crypto assets, like XRP, fit the SEC’s description of securities. Most others, including ETH, may fit it. And the SEC may deem them as such someday.
For now, the Commission has only called out 68 crypto assets by name through three lawsuits. For all practical purposes, however, it considers the overwhelming majority of crypto assets securities, with the notable exception of Bitcoin.
The Timeline of the SEC’s Crypto Regulation Efforts
As the industry demanded regulation, the SEC got busy in December 2020, taking aim at the most obvious crypto asset-deemed-security. It sued Ripple Labs and the people behind the organization for conducting sales of unregistered securities in the form of their XRP tokens. The lawsuit is still ongoing.
- September 2021. The SEC finally decided to pull the plug on Bitconnect, the most infamous crypto Ponzi scheme to date. It charged the lead fraudsters who had pocketed $2 billion from the victims of the scam.
- February 2022. The SEC moved against crypto lender BlockFi, forcing it to pay a $100 million fine for offering an unregistered retail crypto lending product.
- July 2022. Coinbase entered the crosshairs of the SEC. The Commission charged some of its former executives with insider trading.
- November 2022. FTX collapsed, dealing a blow to crypto prices across the board. The SEC brought charges against a slew of FTX executives, among them founder Sam Bankman-Fried. Three of the charged executives have since pleaded guilty.
- January 2023. Crypto exchange Gemini and lender Genesis found themselves the targets of the SEC’s “crusade.” The Commission charged both organizations with dealing in unregistered securities. Genesis went under as a result of the SEC’s move.
- February 2023. The SEC ordered crypto exchange Kraken to stop its US-based crypto staking. It also fined the organization $30 million.
- March 2023. The SEC served Coinbase a notice, warning the exchange that it had violated securities laws. That same month, the CFTC sued Binance, alleging that the exchange allowed US citizens to trade unregistered securities.
- April 2023. Coinbase requested clarifications from the SEC on how to determine which assets are securities, and how to register those that are. Also in April, SEC chairman Gary Gensler appeared before Congress to address concerns about US authorities driving crypto businesses overseas.
- July 2023. The SEC answered Coinbase’s request for clarification, stating that the exchange likely knew it was acting in defiance of US securities laws. According to the SEC, Coinbase’s claims that it was unaware of the nature of some of the assets it had made available through its exchange held no water. The SEC argued that:
- Coinbase had adopted the legal tools and approach of the SEC to determine whether assets were securities.
- It advised some of the asset issuers on its platform to refrain from making statements that would allow the authorities to associate their assets with securities.
- The public filings of the exchange also informed Coinbase investors of risks stemming from the authorities’ interpretation of some of the assets featured on the platform as securities.
- Coinbase applied the right legal rules to evaluate its conduct, yet decided to assume the risk.
The SEC also pointed out that the Howey test required no formal contracts. And, therefore, Coinbase’s claims of a need for a formal contract to attest to the sale of securities were incorrect.
The Commission also clarified that it has full legal authority to enforce securities laws through civil enforcement.
What Does it Mean to Have an Asset Deemed an Unregistered Security?
If you are selling assets that the SEC deems unregistered securities, you are in trouble. To sell a security, you must register it or ensure that it meets a legal exemption.
What is The Difference between Registered and Unregistered Securities?
To sell securities, institutions must file a registration statement with the SEC. The statement includes information about the financial status of the company behind the offering, as well as the offering itself.
A registered security is one the issuer of which has complied with the SEC’s registration requirements and securities laws.
The issuer of a security cannot make a public offering without first registering the security with the SEC. To make a private placement or unregistered offering, the issuer must seek an exemption, like Regulation D.
Issuers who do not register their securities and do not secure an exemption cannot offer them for sale to the public in any form. If you hear about security issuers making unregistered offerings, they do so under the legal coverage of Regulation D or another exemption.
The cryptocurrencies the SEC has deemed securities have not been registered, nor have they been exempted in any form. They exist, therefore, in direct defiance of US securities laws.
How Regulation D Impacts Unregistered Securities
Organizations that issue unregistered securities do not have to register their offerings with the SEC, but they must submit Form D. Otherwise, they cannot legally sell their shares, etc.
The Regulation D exemptions, specifically Rule 504 and Rule 506, allow issuers to sell unregistered securities under strict and well-defined circumstances only. Some of the conditions unregistered securities must meet to fall under Regulation D are:
- Information is available about the past performance of the security.
- Sales exceeding $50,000 or 5,000 shares are preregistered with the SEC.
- The issuer holds the unregistered shares for a set period.
Other conditions also apply.
Other exemptions from registration apply to:
- Private offerings
- Limited-size offerings
- Offerings taking place strictly within a state
- Local and federal government offerings
Knowing this, it is clear that the cryptocurrencies the SEC has classified as securities do not fulfill these conditions and have not been marketed as unregistered securities under a legal exemption. Nor have they been registered with the SEC.
What This Means for the Issuers of These Cryptocurrencies
As the SEC sees it, the organizations and entities behind the cryptocurrencies it has named as unregistered securities have engaged in willful violations of the 1933 Securities Act, and/or the regulations and rules the SEC has set. Such an act constitutes a felony offense and carries a penalty of up to five years in federal prison.
It falls to the courts involved in the ongoing litigations to establish whether the offenses these parties committed were willful.
What This Means for the Buyers of These Cryptocurrencies
If you bought any of the cryptocurrencies the SEC has classified as illegally offered unregistered securities, these are some of the legal consequences you may face:
- Civil liability. By purchasing unregistered securities, investors open themselves to lawsuits from the issuer or other investors.
- Law enforcement action. Authorities like the SEC and CFTC may take legal action against those who sell and buy unregistered securities. These enforcement actions can range from criminal charges to fines, cease and desist orders, injunctions, etc.
- Rescission. If an issuer or seller provides unregistered securities without a legal exemption to a buyer, the buyer may be able to undo the transaction and reclaim the funds invested. Theoretically, the buyers and holders of cryptocurrencies deemed securities may be able to recover the funds they invested.
What if the SEC Compels Cryptocurrency Issuers to Register The Securities They Sell?
If the cryptocurrencies currently deemed unregistered securities become registered securities, they will entitle their holders to all the legal protections security holders enjoy.
Under those theoretical circumstances, cryptocurrency scams would become securities fraud, punishable by up to 25 years in prison and a fine in the US. Such a turn of events would significantly up the ante on cryptocurrency crime.
The law is specific in this case. It strictly prohibits every scheme to defraud people or fraudulently obtain money from commodities or securities. It even punishes attempted fraud to the same extent.
Cryptocurrencies Deemed Securities and Peer-to-peer Transfers
Being deemed securities will complicate the usability of cryptocurrencies for peer-to-peer transfers. Although the law allows the peer-to-peer transfer of securities, it ties it to a number of conditions.
- Transfers must comply with the bylaws of the issuing entity.
- Some transfers may be subject to approval from the board of the issuing organization.
- Some issuing organizations may have restrictions on peer-to-peer transfers.
The conditions involving the issuing organization can be met electronically, as part of the transfer. However, other conditions may also apply.
- To ensure compliance, the SEC may require filings on some peer-to-peer transactions.
- The SEC may use these filings to update the public disclosure records.
Conclusion
Cryptocurrencies the SEC has deemed securities and their issuers are in a difficult legal position. In the view of the SEC, the issuers have willfully broken securities laws. The legal ramifications may even affect buyers and holders.
If the issuing entities register their cryptocurrencies as securities, they will impact the usability of the assets. Whether it will be tenable to keep these cryptocurrencies going following classification as securities depends entirely on the legal flexibility of the SEC and its willingness to accommodate usability-related concerns.
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