Howey Got Here: SEC Issues Guidance On Token Offerings

The Howey test lives on—now in a lesson in what not to do when it comes to token offerings.

Token offerings, also known as "initial token offerings," "token launches," "token sales," "initial coin offerings," or "ICOs," represent a new capital-raising method being explored by many emerging companies; venture, hedge, and private equity funds; large and well-established corporations; and others hoping to raise significant amounts of money quickly and from a broad base of potential participants. Token launches provide issuers with an alternative to more traditional forms of fundraising, such as obtaining venture capital investments, which often involve significant due diligence by investors and dilute founders' equity and rights.

To date, many issuers have launched ICOs from non-U.S. jurisdictions, with some taking the position that, so long as the token being offered was not a security under the laws of the jurisdiction of its issuance, there was no need to consider whether the token constituted a security in the jurisdictions in which such token may have been purchased. Critics of The Decentralized Autonomous Organization—more commonly referred to as The DAO and which used a Swiss foundation in connection with its ICO—have long held the view that, while The DAO was successful in raising a precedent-setting amount of capital from purchasers located across the globe, it likely ran afoul of myriad securities regulations and regimes around the world, including in the United States.

Yesterday, the U.S. Securities and Exchange Commission (the "SEC") spoke formally on the topic for the first time, disappointing some individuals and issuers that had hoped tokens might fall outside of the definition of "securities."1 The SEC also issued an investor bulletin on initial coin offerings as part of its investor-education and investor protection mission.2

Section 2(a)(1) of the Securities Act of 1933 (the "Securities Act") and Section 3(a)(10) of the Securities Exchange Act of 1934 (the "Exchange Act") both include an "investment contract" among the list of instruments that are considered a "security." In SEC v. W.J. Howey Co.,3 the United States Supreme Court articulated a facts-and-circumstances test for determining whether a particular instrument should be considered an "investment contract," and, therefore, a "security" subject to the Securities Act. That test has evolved over the years, but the core factors considered are: whether purchasers of the...