“The test to determine whether a crypto asset is a security is clear.”
— Gary Gensler
When Howey Met Gary
On May 27, 1946, William John Howey had his day in court — and crypto lost.
Howey owned large tracts of Florida land he had developed into citrus groves, financed partly by leaseback agreements: He would sell parcels of land, mostly to guests of his nearby hotel, and then offer to build citrus groves on them, with a cut of the profits going to the new owners.
Because Howey’s company did all of the work — planting the trees, harvesting the crop, selling the oranges — regulators thought it looked less like a contracted service and more like an investment scheme.
The SEC argued that the orange groveswere a common enterprise with the expectation of profit solely through the efforts of others.
The Supreme Court agreed, declaring the orange grove agreements were investment contracts and therefore, as per the Investment Act of 1933, securities.
That 1946 ruling on a law from 1933 remains a Sword of Damocles hanging over the head of the crypto industry in 2022.
Silent, but Deadly
This is a daily newsletter, so once I commit to a topic, there's no turning back.
I generally decide on a subject a day prior so that I can get a few hours of research in before officially declaring myself an expert and writing about it.
Because of the Lummis-Gillibrand bill out yesterday, I committed to write about Howey on the assumption that I'd be sure to find at least one interesting thing to say regarding what is and is not a security.
But a few hours later, all I've really learned is that it has something to do with oranges.
It may be that one afternoon/evening of research is insufficient for this nuanced subject.
(And it may be that my research time sometimes gets cut short by an emergency, like binge-watching the last three episodes of Severance.)
But it may also be that there just isn’t a lot to learn on the subject, simply because not a lot has happened since that fateful ruling in 1946.
What has happened is that Howey has been reinterpreted by lower courts in increasingly expansive ways over the years.
But, despite all of the opportunities, the SEC has declined to give clarity or detailed guidance to issuers as to what exactly they need to do to avoid finding themselves in court.
And that's likely deliberate.
The SEC did release a “framework” for digital assets in 2018, listing 38 separate considerations, many of which include several sub-points, related to the four-part Howey test.
But they dodged the central question, which is how to measure the last and most crypto-relevant clause of Howey: “based solely on the efforts of others.”
Is “efforts of others” inclusive of, say, developers? Or just c-suite type management conducting “essential managerial efforts?” Are those efforts "the undeniably significant ones” which “affect the failure or success of the enterprise," or are they just executing on decisions made by token holders?
Crypto natives like to say decentralization is a spectrum, but I don’t think that will fly with the SEC — I expect they take a binary view of things: You either are or are not decentralized.
How many would currently pass muster as decentralized? It’s impossible to say, because the test does not seem to be clear to anyone other than Gary Gensler and his staff.
And they are in no rush to explain themselves: The SEC is silent but deadly.
(I’ll reluctantly pass on the obvious joke there, because I’m sure your sense of humor is more advanced than mine.)
Ripple went so far as to sue the SEC in an effort to get them to break that silence and offer a better explanation of Howey.
But it’s not in the SEC’s interest to spell things out: The fact that the definition of security stems from a Bing Crosby-era decision on orange groves is probably considered a feature, not a flaw — it allows for broad interpretation.
With the exception of bitcoin, nearly everything could be a security under some reading of Howey.
That could change if Lummis-Gillibrand becomes law by allowing securities that are not fully decentralized to be considered commodities, rather than securities — but only if they do not aim to earn any sort of profit.
Most bills do not become law, however. And, anyway, we’re mostly interested in cryptos that do aim to (someday) make a profit.
So I’m going to take Gensler at his word and assume that almost all cryptos are, in fact, securities.
Because when Howey met Gary, it was a perfect match.
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