Six top law school professors besieged the US SEC, is cryptocurrency a security?
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Author | jk
In the past few days, law professors from Yale University, the University of Chicago, the University of California, Los Angeles, Fordham University, Boston University, and Widener University filed an amicus brief that retroactively investment contracts The history of the terms meaning before, during, and after the passage of the Federal Securities Act in 1933 completely refuted the SECs investment contract theory.
Here are the scholars conclusions:
In 1933, state courts reached a consensus on how to interpret the term investment contract as a contractual arrangement that entitles the investor to a share in the subsequent income, profits, or assets of the seller. contract share.
After the Howey case was decided in 1946, the common feature [of investment contracts] remains that... by virtue of its investment, the investor must be promised that he will have a continuing contractual interest in the income, profits, or assets of the enterprise.
Every investment contract identified by the Supreme Court involves a contractual promise to confer a continuing interest in a business.
@MetaLawMan on Twitter said: In my opinion,The amicus curiae opinion dealt a fatal blow to the SEC’s argument that cryptocurrencies traded in secondary markets are investment contracts.
Background: Blue-Sky Laws
When Congress included the term investment contract in the definition of security, the term had a clear meaning in Blue-Sky Laws, requiring contracts to promise future value.
By the time Congress adopted the Securities Act and the Exchange Act, nearly every state had passed state laws regulating securities trading. In defining a set of national standards and federal regulatory programs, Congress chose to create federal laws based on these so-called blue sky laws. Most relevantly, in defining securities covered by the new state securities laws, Congress imported the term investment contract from these blue sky laws as a whole.
With this background, we review the development of the concept of “investment contract” under the Blue Sky Act cited by Howey as the basis for a “unified” definition of that term.
In the early 20th century, some states in the United States began to enact the first batch of blue sky laws.
At the turn of the 19th century, as the U.S. economy boomed, so did the market for trading shares in U.S. businesses. Opportunities to invest in blue-chip stocks grew as middle-class and retail investors flocked to the big exchanges in New York and San Francisco to buy shares in commercial enterprises from industrial giants ranging from railroads to heavy industry. But at the same time, there is an increase in speculative or outright fraudulent investment opportunities from questionable sellers, such as flash-in-the-pan companies, fantasy oil wells, remote gold mines, and other similar fraudulent developments. Unlike their blue-chip relatives, these investment opportunities are often sold in person, in newspapers, and even by mass mail. Unsurprisingly, the marketing of these investment opportunities is often tinged with clever blowing and fraud.
Beginning in 1910, state legislatures responded to these developments by enacting the nations first securities laws. These initial legislative efforts are aimed at protecting the public from dishonest salesmen selling shares under blue skies.
The first blue sky laws were relatively simple and did not specify the tools they covered. For example, Kansas 1911 securities law has been hailed as the first blue sky law. It simply requires investment firms to register any stocks, bonds or other securities of any kind or nature before they can sell them.
Other states have attempted to provide some clarification on what is considered a securities.For example, the initial statutes in California and Wisconsin explicitly stated that security meant traditional instruments such as stocks, stock certificates, bonds and other evidence of indebtedness.
Lawmakers quickly saw the need for a second-generation securities law. In fact, the bad, speculative, or fraudulent investment deals or schemes that sparked the enactment of the first blue sky laws werent technically stocks or bonds. These deals, disguised as traditional stocks, propose giving investors in exchange for an initial amount, a contractual right, to capture the future value of the business, just like stocks or bonds. And, given that these laws focus on real stocks and bonds, these fake stocks and bonds are clearly exempt from the first generation of blue sky laws.
Subsequently, these states expanded the blue sky law to include investment contracts, which included the new form of stocks and bonds.
In order to clearly align these new instruments or propositions, which share key economic and legal characteristics with stocks and bonds, state legislators sought to explicitly align and regulate them in second-generation securities laws.
Minnesota added the term investment contract to its definition of securities in its Blue Sky Act of 1919. This new undefined term is intended to capture those investments that, while not officially stocks or bonds, are contingent upon and give a contractual right to future profits. Other states soon followed suit, adding investment contracts to the list of instruments covered by their blue sky laws.
Minnesota Interprets Term Investment Contract in Gopher Tire Case
Although, as noted above, the term “investment contract” is not defined in the law itself, the courts were quick to provide a definition based on the intent and context in which this statutory term was adopted in blue sky law. In several early Minnesota cases, including one cited by the Supreme Court in Howey, 328 US 298 n.4, the state Supreme Court examined the key characteristics that an instrument or collection of rights needed to satisfy in order to be deemed an investment contract. . These rulings are considered authoritative interpretations of the original meaning of the term.
In Gopher Tire, a local tire dealer sold credentials of its business to investors. Gopher Tire, 177 NW 937-38. Under the agreement, investors will pay $50 and agree to promote the dealers merchandise to others. In exchange, investors receive a voucher that gives them the contractual right to receive a percentage of the dealers profits. Parsing the definition of securities in the Blue Sky Act, the court ruled that the certificates were not technically or formally stock. Even so, the Minnesota Supreme Court ruled that the certificates can properly be considered investment contracts.In making this ruling, the court reasoned and emphasized that these certificates share the same key characteristics as stocks, namely that the investor provides funds to the dealer and in return, the investor contractually receives a share of the companys profits. right.
Other early Minnesota cases followed this early judicial test to define statutory terms. In Bushard, the Minnesota Supreme Court faced another dispute over whether a contractual profit-sharing arrangement was an investment contract. Here, a bus driver paid the bus company $1,000 and in return received a contract that promised the driver a certain salary plus a share of the bus companys profits (in addition to an eventual return of his $1,000 investment) . According to Gopher Tires ruling,The court ruled that the arrangement was an investment contract based on two key factors: the driver (i) invested with the intention of making a profit and (ii) in exchange received a contract (operating Contractor Agreement), which ensures the rights and interests of the future profits of the enterprise.
In summary, early Minnesota cases revolved around two statutory terms: contract and investment. An arrangement is considered an investment contract if: (i) the investor acquiresContractual commitment, and (ii) in exchange for an investment, the investor is promised a share in the future revenue, profits, or assets of the business.
By the time the Securities Act and the Exchange Act were adopted, the term investment contract had a defined meaning.
By 1933, when the Securities Act was enacted, 47 of 48 states had passed their own blue sky laws, many involving investment contracts (following Minnesotas lead). Moreover, in the decades before 1933, when state courts applied the term investment contract to various arrangements, they agreed on a unified meaning. As Howey explained, this is the meaning adopted by Congress.
In short, by 1933, state courts had reached consensus on how to interpret the term investment contract as a contractual arrangement that entitles the investor to a share of the sellers subsequent income, profits, or A contractual share of the asset. Indeed, to the best of our knowledge, no state court decision appears to have found an investment contract in the absence of these key features. In some decisions, such as Heath, the courts openly proposed that an investment contract required an actual contract. In other decisions, courts have highlighted the sellers obligation to pay (and the holders right to receive) a portion of its future value in exchange for the initial capital outlay. Courts typically rely on this requirement to distinguish bona fide investment contracts from basic asset sales.
Investment contracts since the Howey judgment
In the more than 75 years since the Howey decision, courts have applied the Supreme Courts seemingly simple test to all novel and complex business circumstances, generating a complex web of precedents. The common thread remains that—as state courts interpret state blue sky laws, and as Howey requires—investors must be promised, as a result of their investment, an ongoing contractual interest in the businesss income, profits, or assets. In this section, we discuss some of these cases.
A. The Howey test requires consideration of whether a proposal resembles the general concept of a security.
The Supreme Court has interpreted the term investment contract several times, including, of course, in Howey itself. Each time, in applying the Howey test, the court considered whether the transaction reflected what is generally considered to be an essential property of the security.
In addition, the court considered the arrangements comparison to other instruments previously considered securities. For example, the Forman case. There, the court observed that there was no distinction between an “investment contract” and an “instrument commonly referred to as a security,” another enumerated term in the statutory definition of “security.” Applying Howey, the court held that shares in a nonprofit housing cooperative were not “investment contracts” because investors were motivated “solely to obtain a place to live rather than to obtain a financial return on their investment.”
Marine Bank provides another example. There, a couple guaranteed a loan for a meat company and exchanged certificates of deposit for a share of the companys profits and the right to use its facilities. The court ruled that neither the certificate of deposit nor the subsequent agreement between the couple and the company were securities.
Here, case law from the states—from before 1933, see Section I above, and from federal courts after 1933—emphasizes that to have an “investment contract” through which the investor may obtain A certain contractual interest of the enterprise is obtained by way of profit.
B. Every investment contract as defined by the Supreme Court involves a contractual promise to grant a continuing benefit to a business.
Echoing state court decisions that preceded the Blue Sky Act of 1933, Supreme Court decisions after Howey recognized that the holder of an “investment contract” must be promised a right to an ongoing participation in the income, profits, or assets of the enterprise.
In International Brotherhood of Teamsters v. Daniel, 439 US 551 ( 1979), the Court placed particular emphasis on this theme. There, the court observed that in every decision in which this court considers a security to exist, a person deemed to be an investor chooses to forego specific consideration in exchange for a separable financial benefit characteristic of a security. The court found There was in fact no separable financial interest having the character of a security before it. Specifically, it concludes that non-contributing, mandatory pension plans are not securities because pension benefits purported to be securities represent only a small fraction of the overall, non-securities compensation individuals receive as a result of their employment part.
To date, every arrangement that the Supreme Court has considered an “investment contract” promises the investor some ongoing, contractual interest in the business’s future endeavors. SEC v. CM Joiner Leasing Corp., a case that preceded Howey three years ago, involved the provision of land leases near planned oil well test wells in exchange for investors sharing in the value of discoveries from an ongoing exploration enterprise.
Howey itself involves providing small plots of land in citrus groves and contracting with promoters to harvest, market and sell the citrus in exchange for a net profit distribution based on inspections at the time of picking.
C. Other relevant judgments
First, the two post-Howey “investment contract” decisions—SEC v. Variable Annuity Life Ins. Co. of Am., 359 US 65 (1959) and SEC v. United Benefit Life Insurance Company, 387 US 202 (1967)— It concerns annuity plans under which investors pay premiums into investment funds managed by life insurance companies and are entitled to a proportionate share of the proceeds.
The Tcherepnin case involved the offer of revocable capital shares in an Illinois savings and loan association, giving investors who purchased those shares the right to become members of the association, vote their shares, and become a member of the associations board of directors based on the associations profits. Dividends declared”.
Finally, the Edwards case involved a post-sale lease scheme in which a promoter provided a payphone, as well as a site lease, lease buy-back and management agreement and buy-back agreement which entitle the investor to receive benefits from the day-to-day operation of the payphone Earning a fixed annual return of 14%, the payphones are leased back and managed by the promoter.
Among other things, the professors found that every “investment contract” identified by the Second Circuit involved a contractual promise to confer a continuing benefit on the business, and cited more than a dozen examples of this.
Why is this considered to thoroughly disprove the SECs argument?
Based on the above, when Minnesota defines investment contract, it mainly focuses on the two core concepts of contract and investment. Its definition focuses on the investors acquisition of some form of contractual commitment in a commercial enterprise, and the right to share in the future income, profits or assets of the enterprise as a result of the investment. This definition is based on the traditional concept of capital investment and profit sharing.
However, existing cryptocurrencies differ from this definition. first,Purchasing a cryptocurrency does not mean that the investor will receive any kind of contractual commitment, or a clear profit-sharing right in a commercial enterprise. The value of cryptocurrencies is usually based on market demand and supply, technological advancements, or other external factors, rather than on profit sharing with a particular company or business.
Secondly,Holders of cryptocurrencies generally do not expect or depend on a particular business or individual for returns or profits. Their returns are usually derived from the appreciation of the currency, which is determined by market forces rather than being driven by a specific business activity or profit.
In general, although cryptocurrency involves investment to some extent, its nature, return mechanism, and relationship to the traditional sense of contract and investment contract make it not easy to be included in Minnesota Investment Contract Definition in Early State Cases.
In the same way, according to the relevant definitions demonstrated in this article, unlike traditional securities or investment contracts, the core value of cryptocurrency mainly depends on its characteristics as a commodity. First of all, cryptocurrency, such as Bitcoin, was originally designed as a digital currency to provide a decentralized payment method that is not bound by the traditional banking system, which is also used as a payment method in the current major public chains. The means of gas fees is proven. This means that it is essentially a medium of exchange and has the same commodity value as gold or other items.
Furthermore, the value of a cryptocurrency depends largely on its scarcity, authenticity, and unforgeability. For example, the total amount of Bitcoin is limited, just like gold, which has a fixed supply. This scarcity gives it commodity value. Additionally, blockchain technology ensures the authenticity and uniqueness of each cryptocurrency unit, making it difficult to be counterfeited or copied.
These properties make cryptocurrencies more like gold, crude oil, or any other form of physical commodity than a security or investment contract in the traditional sense. While people do buy cryptocurrencies as investments expecting their value to rise, this is no different than people buying gold or art expecting it to appreciate in value. Therefore, from this point of view,Cryptocurrencies should be viewed more as an asset with commodity value rather than a security or investment contract in the traditional sense.
