From Citrus groves to crypto tokens, the so-called 1946 Supreme Court Howey test for investment securities confronts the digital age. And it has left startups and token lawyers scratching their heads saying, “So what exactly is this Howey test? And what constitutes a security in token offerings?”
This year alone, technology startups have raised a staggering $3.2 billion through Initial Coin Offerings, or ICOs, with the cumulative value of token sales skyrocketing by more than 1100 % in the past year alone, according to CoinDesk’s ICO Tracker.
Also known as “Token Sales,” ICOs enable startups to raise money for their projects by selling crypto coins as a form of equity both to sophisticated investors and the average public. This democratization of fundraising through ICOs has generated a level of excitement, some say greed, comparable to the old days of gold prospecting in the Wild West.
“Anytime you have new concepts that are disruptive to old ways of doing things,” says Paul Atkins, CEO of Patomak Global Partners, “That gets a lot of people interested and focused.”
Including at the U.S. Securities and Exchange Commission, (SEC), where Atkins once served as a commissioner. In July, the federal agency issued an investigative report warning startups that their tokens could constitute securities and subject to federal securities laws. “We seek to foster innovative and beneficial ways to raise capital,” said SEC Chairman Jay Clayton, “While ensuring – first and foremost – that investors and our markets are protected.”
But the SEC report, much of it based on an obscure 1946 Supreme Court test called the Howey test involving Florida citrus grove investments, has only raised more questions than it has answered and has token lawyers reaching for their legal tomes to see exactly how that historic case relates to modern day digital assets. As ICOs skyrocket in popularity as a viable alternate form of capital raising, and given the steep penalties for non-compliance with securities laws, there’s a growing sense of urgency around finding ironclad answers to some of these challenging questions. For instance, what constitutes a security when it comes to digital tokens? How does the Howey test apply to the different examples of tokens surfacing daily? And most importantly, how can startups issue tokens without running afoul of the law.
“Lots of tokens, especially the tokens we’ve seen over the last year, probably have passed the Howey test, which is a bad thing when you’re a token seller,” says Marco Santori, a partner and head of the fintech practice at Cooley LLP., and a noted ICO expert. “It’s the one test you don’t want to pass.”