The SEC Ruling on DAO Token and ICO Offerings – Where They May be Wrong
Yesterday, I wrote a post titled, “ICO Tokens & the SEC: Are Tokens Considered Securities?” where I discussed my opinion on the issue of tokens being securities or not. Interestingly enough the SEC came out with a ruling yesterday on this exact topic and I would like to look at the ruling and see if it is true that all blockchain based companies and projects are “securities”. The ruling was based on the structure of the infamous DAO token offering and its disastrous ending.
All quotes are from the ruling which you can see in its entirety here: http://bit.ly/2v6Ls9R
This was the ruling of the SEC:
“Based on the investigation, and under the facts presented, the Commission has determined that DAO Tokens are securities under the Securities Act of 1933 (“SecuritiesAct”) and the Securities Exchange Act of 1934 (“Exchange Act”).”
Just as a refresher, we will repeat the guidelines from the case of SEC v. Howey here:
Under the Howey Test, a transaction is an investment contract if:
- It is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
Was the DAO Token a Security?
Let’s look at each of the requirements under the Howey rule and see if the DAO token met the requirements and were therefore “securities”.
It is an investment of money:
The SEC gives this definition of the investment of money:
“An investment contract is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. In determining whether an investment contract exists, the investment of “money” need not take the form of cash. Howey’s reference to an ‘investment of money,’ it is well established that cash is not the only form of contribution or investment that will create an an investment contract.”).”
As the contributions were made in ETH in exchange for DAO tokens, they are therefore considered an investment in money and would fulfil the first criteria of the Howey Test and be considered a security. One down, three to go.
There is an expectation of profits from the investment
The SEC describes how the promoters of the DAO project did promote the token’s purpose of allowing the holders to share in the profits of the DAO from its different projects.
“Investors who purchased DAO Tokens were investing in a common enterprise and reasonably expected to earn profits through that enterprise when they sent ETH to The DAO’s Ethereum Blockchain address in exchange for DAO Tokens. “[P]rofits” include “dividends, other periodic payments, or the increased value of the investment.”
It is pretty clear here that this requirement of the Howey ruling again applies to the DAO and its contributors, thus leading towards the SEC’s decision.
The investment of money is in a common enterprise:
For this one, we do not need to go to the SEC. It seems rather obvious that the contributors were all participating in a common enterprise. So we have met three of the requirements of the Howey rule.
Any profit comes from the efforts of a promoter or third party:
Although the holders of DAO tokens had some level of voting power the SEC points out that it was limited.
“Investors’ profits were to be derived from the managerial efforts of others—specifically, Slock.it and its co-founders, and The DAO’s Curators.”
So, once again we see that the DAO meets this requirement of the Howey test and would be considered a security. As you have seen, the DAO token fulfils all the requirements of the Howey Act and therefore falls under the rules of the the Securities Act of 1933 (“SecuritiesAct”) and the Securities Exchange Act of 1934 (“Exchange Act”).
Why Do I Think the SEC Ruling May Be Wrong?
With all the evidence given above, the obvious question is what am I talking about? How can I say the SEC was wrong about DAO and ICOs and tokens. I think that it is a bit misleading as the SEC made its first ruling regarding tokens based only on the DAO token. There is a clear distinction between Profit Sharing tokens (like DAO) and “Utility Tokens”.
We have already shown how profit sharing token should be considered securities and require registration with the SEC and follow its guidelines. In the ruling, the SEC explains the ramifications of the decision and the need for regstration and what it includes. I will not get into this here.
What the SEC is missing is the differentiation between these and other tokens that do not meet the Howey rule. Almost all of the tokens issued are for the future use of a project or platform that is being developed. It is like the “money” that will be needed to access the project and participate in the usage of that project. It is not an investment with the expectations of returns. One may argue that the tokens trade on exchanges, so aren’t they securities? I would say that the exchange is reflecting what the market perceives as the value of the future usage of the platform and not the value of the company.
After the SEC decision was released, I discussed, through slack the issue with two ICOS. The Presearch ICO team, that is now in progress and the Kin token team that is to launch an ICO in the future. Both teams denied the issue related to their tokens as they are utility tokens and not securities and both projects will take investments from US citizens.
To be fair to the SEC and their ruling, they do say the following:
“Conclusion and References for Additional Guidance
Whether or not a particular transaction involves the offer and sale of a security— regardless of the terminology used—will depend on the facts and circumstances, including the economic realities of the transaction.”
Conclusion of My Thoughts on the SEC Ruling on DAO Token
I hope that the SEC, given the last quote just above, looks at the different types of tokens and considers the difference. If they look at it objectively, it is hard to see how utility tokens should be classified as securities.
Disclaimer: I am not a lawyer and in no way an expert on Securities Law. This is just my opinion.
For more of my thoughts, see this section of my blog: https://urbancrypto.com/category/blockchain-my-thoughts/