The United States (“US”) Congress shall finally be able to witness cryptocurrency legislation in the form of the Digital Commodity Exchange Act (“DCE Act”) and the Securities Clarity Act (“SC Act”). Not only will the 2 (two) pieces of legislation help regulate trade in cryptocurrencies but also enhance the blockchain adoption process, for which the US has been trying to win the front runner status. Interestingly, the years 2019 and 2020 has seen many pro-blockchain legislations, however, the implementation of the same is yet to be seen by the US legislators. In this 2 part alert, we shall be discussing the change which is likely to be brought by the DCE Act and the SC Act. In the present alert, the ambit of the SC Act shall be discussed.
The US Securities and Exchange Commission (“SEC”) up till now has mostly followed the regulation by enforcement rule. In the year 2020 itself, the SEC has enforced various litigations against token offerings and money laundering infringements on cryptocurrencies (some of which we have covered on our previous alerts). In this regard, the SC Act shall come as a relief to most firms looking to have a developed standard for tokens offerings and utilise the blockchain to its full potential. The discussion draft for the SC Act (“Draft”) provides the object as ‘to amend the current securities laws to exclude investment contract assets from the definition of security’. This in itself should appear as a welcome move amongst cryptocurrency businesses as through the passing of the SC Act, any digital assets which are sold or transferred under the ambit of an investment contract would not automatically become a ‘security’ within the meaning of section 2(a) of the Securities Act, 1933 (“Securities Section”).
The Draft discusses the possibility that at times when for fundraising activities, certain digital assets are sold as investment contracts to qualify as securities, the underlying assets sold pursuant to these arrangements themselves may not qualify as a ‘security’ under the Securities Section. The Draft further discusses the protocol of the Howey Test which has been the holy grail for the SEC to issue sanctions on digital tokens which may have been unregistered as securities under the Securities Act, 1933. The case of SEC v. W.J Howey and Co. 328 U.S 293 (1946) lays down the test for admissibility of securities in the US for regulation by the SEC. For this purpose, most enforcement agencies have determined that the definition of investment contracts for the purpose of Securities Act, 1933 means “a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party". What is interesting to note here is that the definition automatically does not qualify the underlying assets of an investment contract to be determined as securities as well. However, at times the SEC has also conveyed the meaning of the underlying assets to be within the meaning of security, hence causing a conflict (read our alert on the telegram case).
Through the passing of the SC Act, this conflict is likely to have more regulatory clarity as the object of the SC Act is to separate the underlying assets from the issuing investment contract. The quoted purpose as provided is “The purpose of this Act is to clarify and codify that an asset sold pursuant to an investment contract, whether tangible or intangible (including an asset in digital form), that is not otherwise a security under the Act, does not become a security as a result of being sold or otherwise transferred pursuant to an investment contract”
The SC Act will indeed provide an extensive shift in the approach which has been taken by enforcement authorities in the US. Most likely, the paradigm shift shall be able to provide a balance of approaches between the issuers of such digital assets and the SEC. Moreover, entrepreneurs can now also get more innovative with their fundraising schemes.
Authored by Samaksh Khanna, and Shivani Agarwal, at BlockSuits.
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