On Tuesday, March 19, the SEC issued joint guidance with the CFTC to “finally” clarify how securities laws apply to digital assets. On many issues, including staking and meme coins, the SEC’s new guidance is a welcome development and a marked improvement from Gensler’s time. He also rightly acknowledges that the agency’s “regulation by enforcement” campaign under Gensler’s presidency had blurred compliance obligations and stifled the industry. But in one important way, the guidance fails to provide the comprehensive correction that the crypto industry needs.
The greatest gap lies in the SEC’s articulation of Howey test for “investment contract” securities. All agree that most digital assets do not constitute, in themselves, investment contracts. Even the Gensler SEC (eventually) admitted this, and the SEC’s new guidance reiterates this position. The key question, however, is when a digital asset is sold under an investment contract such that the sale is subject to securities laws.
The law provides the answer. From the point of view of text, history and common sense, an “investment contract” means a contract – an express or implied agreement between the issuer and the investor under which the issuer will generate continuing profits in exchange for the buyer’s investment. Most digital assets are not investment contracts because they are not contracts. A digital asset can be the subject of an investment contract (like any other asset), but it can still be sold separately from the investment contract without involving securities laws. In the lawsuits filed by Gensler, the crypto companies vigorously defended this correct interpretation of the law.
Yet the new SEC guidance is silent on whether an investment contract requires contractual obligations. Instead, it states that an investment contract travels with a digital asset (at least temporarily) when the “facts and circumstances” show that the developer of the digital asset “incentivizes[ed] an investment of money in a joint venture with representations or promises to undertake essential management efforts,” leading buyers to have a “reasonable expectation of profit.” This does not clearly confirm a clear departure from the SEC’s former view that Howey avoids “contract law” and requires “a flexible application of the economic reality surrounding the offer, sale and entire project in question, which may include a variety of promises, commitments and corresponding expectations.”
Gensler SEC’s “know when I see” approach to Howey was deeply problematic. This allowed the agency to piece together an “investment contract” from various public statements from digital asset developers – tweets, white papers and other marketing materials – even in the absence of concrete promises from the issuers. And it failed to distinguish titles from collectibles like Beanie Babies and trading cards, whose value depends heavily on their manufacturer’s marketing and attempts to create scarcity. The SEC missed an important opportunity to clearly reject this approach and reestablish a key statutory dividing line between assets and securities: the contract.
The SEC can still resolve this issue, but to do so it will need to further clarify how the agency intends to apply Howey moving forward – and finally breaking definitively with Gensler’s overly broad interpretation of securities laws. For example, the Gensler SEC has repeatedly cited various “widely disseminated promotional statements” as the basis for introducing a digital asset into the area of investment contracts. The SEC’s new guidance puts guardrails on this approach by requiring that a developer’s statements or promises be “explicit and unambiguous,” “contain sufficient detail” and take place before the digital asset is purchased. But even this improved approach leaves too much room for interpretation. It could be widely enforced by private plaintiffs, courts, or a future SEC. Rather than continuing down the path Gensler took, the SEC should clarify that simple public statements affecting value are insufficient and that promises and representations must be made in the context of the specific sale in question – and not tied to white papers or social media posts that many buyers have likely never considered.
The SEC should also clarify its approach to secondary market trading. Fortunately, the agency now recognizes that digital assets are not “in perpetuity” investment contracts simply because they were once “subject to” investment contracts. But the agency also says that digital assets remain “subject” to investment contracts traded on secondary markets (like exchanges) as long as buyers “reasonably expect” issuers’ “representations and promises to remain connected” to the asset. The SEC says little about how to evaluate these reasonable expectations, providing only two “non-exclusive” examples of when an investment contract “departs” from a digital asset. And it says nothing about whether a secondary market buyer must have a contractual relationship with the token issuer. This leaves it unclear whether the SEC has truly evolved from the Gensler-era idea that investment contracts “travel with” or are “embodied” by cryptographic tokens.
Instead of these mixed messages, the SEC should impose meaningful restrictions on the application of securities laws to secondary market transactions by adopting the approach of Justice Analisa Torres in Ripple. Judge Torres recognized that it is unreasonable to infer an investment contract in the context of blind “buyer-seller” transactions, that is, transactions in which the counterparties do not know each other’s identities (as is common in the secondary market). Since buyers do not know whether their money is going to the token issuer or an unknown third party, they cannot reasonably expect the seller to use the buyers’ money to generate and make profits. The SEC should expressly endorse Judge Torres’ analysis.
These are not academic quarrels. The current SEC may not read or apply its new guidance in a way that threatens the viability of the crypto industry in the United States. But by failing to clearly reject the excesses of the Gensler era, the SEC’s new guidance exposes the industry to a future SEC that could exploit ambiguities in current SEC guidance to resume regulation through enforcement. Private plaintiffs could attempt to do the same in lawsuits against key industry players (such as major exchanges). And in the meantime, the SEC’s interpretations could distort the basis of securities law when negotiating market structure disputes.
The SEC has requested comments on its guidance, and the industry is expected to comply. The SEC should get credit where credit is due. But the industry should not hesitate to point out the flaws and lingering ambiguities in the agency’s approach and advocate for clear, meaningful, and permanent restrictions to ensure regulatory clarity and stability. It is not enough to spruce up the legal architecture of the latest enforcement campaign.
