While the existence of UFOs is still up for debate, there has been a confirmed sighting of a UTO (Utility Token Offering). On April 3, 2019, the SEC Division of Corporation Finance issued a no-action letter to TurnKey Jet, Inc. (“TKJ”) in response to TKJ’s proposed unregistered offering of a utility token. As discussed below, while fairly narrow, the staff no-action letter provides helpful guidance, providing specific circumstances in which the staff of the Division of Corporation Finance (“Division”) would not consider the offering of a utility token as involving the offering of a security.
On the same day, the SEC staff Strategic Hub for Innovation and Financial Technology (“FinHub”) FinHub issued a “Framework for ‘Investment Contract’ Analysis of Digital Assets.” The Framework provides an analysis of applicable securities laws and precedent (including the Howey1 test), as applied to the offering of digital assets. The TKJ no-action letter and the Framework add some much-welcomed insight into the SEC’s thinking regarding the offering of digital assets and how such offerings implicate federal securities laws.
The Framework
FinHub prepared the Framework to help market participants analyze whether a digital asset has the characteristics of one particular type of security – an “investment contract.” This guidance comes after several unregistered digital securities offerings have led to adverse consequences for token issuers and other involved parties.2
The Framework is part of the SEC’s continuing effort to assist digital asset issuers in compliance with federal securities laws and consolidates much of what was already publicized by the SEC in various speeches, releases and staff guidance regarding its treatment of digital assets. Together with recent enforcement actions,3 the Framework provides significant guidance for token issuers and other market participants.
The Framework focuses on the factors of the Howey test; while it summarily reviews many of the factors, it provides a fairly detailed discussion of “Reasonable Expectation of Profits Derived from Efforts of Others,” highlighting the importance of this factor in the analysis. Among the various considerations listed that may affect a digital asset’s status as an investment contract are matters involving network and token development and marketing, sales, transfers and use cases of tokens. Further, the Framework notes that changing circumstances may lead to a situation where a digital asset previously sold as a security may later lose its status as a security under certain circumstances. This possibility, which was previously discussed by the staff and the SEC, is a significant development in the SEC’s stance on digital assets.
It is important to note that the Framework does not contain an exhaustive analysis of the Howey test, or other relevant caselaw, and that the Framework only represents SEC staff views and is not a rule, regulation or statement of the agency.
TKJ No-Action Letter
In its request for no-action, TKJ limited itself to a narrow set of facts that paints a picture of a “pure” utility token. TKJ’s token, which can only be used to purchase air charter services on TKJ’s platform, can only be transferred within TKJ’s platform, and TKJ would offer no distributions to any tokenholders. Additionally, any marketing materials for the offering would focus primarily on the token’s usage for air charter services, rather than the token’s potential appreciation in value.
The Division staff stated that it would not recommend enforcement action if (i) no funds from token sales are used to develop TKJ’s blockchain platform, network or app; (ii) tokens are immediately usable when sold; (iii) token transfers are restricted to TKJ wallets, rather than wallets external to the platform; (iv) token price is valued at one U.S. dollar, and tokens can only be resold to TKJ at a discount to their face value; and (v) marketing materials focus on token functionality rather than potential increase in market value.
The TKJ no-action letter’s restrictions on the token’s functionality, transferability and marketing are consistent with factors espoused by the Framework, and the TKJ no-action letter demonstrates that it is possible to structure public offerings of utility tokens without running afoul of U.S. securities laws. While the narrow facts of TKJ’s offering may not be suitable for certain projects, they provide a solid foundation upon which token issuers can rely.
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Although the Framework and TKJ no-action letter provide some guidance as to when a digital asset falls under the definition of a security, the analysis remains highly complex and involves review on a case-by-case basis. Additionally, the laws and regulations surrounding digital assets are subject to constant change. Seward & Kissel has decades of experience applying Howey and other relevant cases to complex financial products and providing advice on structures that avoid creating investment contracts. If you have any questions regarding issues that may arise in connection with activities related to digital assets, please speak with your Seward & Kissel contact attorney.
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1 SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
2 See, e.g., Seward & Kissel Client Alert, “SEC Divisions Issue Public Statement Addressing Recent Digital Asset Securities Actions,” November 20, 2018; Seward & Kissel Client Alert, “SEC Charges EtherDelta Founder with Operating an Unregistered Securities Exchange,” November 9, 2018.
3 See Seward & Kissel Client Alert, “Self-Reporting Pays Off: ICO Issuer Settles SEC Registration Charges without Penalty after Self-Reporting,” February 22, 2019; see also Seward & Kissel Client Alert, “SEC Divisions Issue Public Statement Addressing Recent Digital Asset Securities Actions,” November 20, 2018.
