Big, important speech yesterday from Bill Hinman from the SEC. The speech clarified that SEC staff does not currently view ether as a security and provided more guidance about how staff will view the sale of blockchain-based tokens.
sec.gov/news/speech/sp…
sec.gov/news/speech/sp…
The press has focused on points related to ether. Below will focus on other important aspects of the speech, which hopefully will help entrepreneurs, investors, and lawyers navigate what still appears to be treacherous waters when it comes to token sales.
Before addressing substantive points, it's important to emphasize that the speech is notable because Hinman is the Director of Corporation Finance at the SEC, the part of the SEC generally responsible for policy related questions--particularly as they related to public markets.
It's also important to recognize that the speech is not legally binding.
The core of the speech dealt with a vexing question of whether a "a digital asset offered as a security can, over time, become something other than a security."
The core of the speech dealt with a vexing question of whether a "a digital asset offered as a security can, over time, become something other than a security."
In other words can a digital asset sold as a security "transmute" as VC-backed advocacy groups and their lawyers have argued with thin (or frankly non-existent) legal support.
The answer to that question predictably appears to be "no." Rather, as framed by Hinman, the appropriate question is “Can a digital asset that was originally offered in a securities offering ever be later sold in a manner that does not constitute an offering of a security?”
The view of the staff appears to be a qualified "yes" in what appears to be highly limited instances where: (i) there is no longer a central enterprise being invested in ...
and (ii) the asset is ONLY being sold to end users who will purchase a good or service available through a network. 
We'll unpack those two pieces later, and in particular the second point because it raises a question of whether you can sell a token to emerging "cryptofunds."
However, before doing so, it's important to note that Hinman first provides some additional gloss on how the SEC Staff may view sales of tokens to investors that occurred during the recent "token boom."
In many instances, it appears that tokens sold to investors will be characterized as securities, including if the entrepreneur pre-sold the token through some sort of pre-sale agreement (like a SAFT) where they expressly promised profits
The above statements appear to be consistent with previous comments by officials from the SEC, along with evidence that there are dozens of active investigations involving token sales to investors.
It's also consistent with what we flagged in our initial report on token sales facilitated via the SAFT.
(Sidebar, these investigations are seemingly so pervasive that rumor has it that a prominent law firm with a sizable "ICO" practice includes in its pitch decks to prospective clients a slide that says something to the effect pf "SEC subpoenas are part of the process.")
Importantly, Hinman acknowledges--as I have argued with Jonathan Rohr--that a "token – or coin or whatever the digital information packet is called – all by itself is not a security. . . .
.. Central to determining whether a security is being sold is how it is being sold and the reasonable expectations of purchaser"
In other words, as is evidence from a cursory review of the case law, manner of sale matters here: "The digital asset itself is simply code. … "
The way it is sold – as part of an investment; to non-users; by promoters to develop the enterprise – can be, and, in that context, most often is, a security – because it evidences an investment contract. And regulating these transactions as securities transactions makes sense"
These statements are important. If tokens sold to investors are deemed securities, it raises a host of problems for parties selling, advising, and investing in these tokens, particularly if the sale did not comply with securities laws.
That being said, and this is where the speech gets interesting, the ongoing sale of digital asset may not longer involve the sale of a security according to the view of the staff if the network is sufficiently "decentralized."
Reason being there is no central party to "the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful."
That's why Hinman indicated that given the current state of the Bitcoin and Ethereum networks it makes little sense to impose the existing disclosure regime.
The speech indicated that there may be other networks that become sufficiently "decentralized" where regulating the tokens as securities may not be required.
As framed by Hinman, "where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts" the sale of the token at that time may not implicate securities laws.
The inquiry appears to be--in the view of the staff--dynamic and not static and will seemingly apply even if there is utility.
So that presumably means that tokens network that were at one point in time "decentralized" could "centralize" and fall under the scope of the securities law regime. (Consider what this means for Ripple or if another fork of Bitcoin that consolidates it operation further.)
The speech did not provide much guidance as to what "decentralization” means outside of the above.
My sense is that these questions will clog courts for years as part of litigation. We'll probably only gain clarity in 5 years or so as these litigations wind their way through district and Circuit Courts.
This is especially true because what qualifies as "essential managerial efforts" under current case law appears to be minimal. All told, it's entirely likely that this "test" will only apply in a handful of cases and be highly fact specific.
That will make it incredibly difficult for lawyers to provide clear advice until there: (i) more guidance on this point from the SEC; (ii) additional legislation; or (iii) actual case law.
Those that argued for this test may soon recognize that they should be careful what they ask for! A test around amorphous, technology specific terms like "decentralization" may enable the government to pick and choose winners
And may prove impossible to apply in a predictable way.
Due to these risks, Hinman notes that many in the industry "are beginning to realize that, in some circumstances, it might be easier to start a blockchain-based enterprise in a more conventional way
"In other words, conduct the initial funding through a registered or exempt equity or debt offering and, once the network is up and running, distribute or offer blockchain-based tokens or coins to participants who need the functionality the network and the digital assets offer"
"This allows the tokens or coins to be structured and offered in a way where it is evident that purchasers are not making an investment in the development of the enterprise."
This is a point I along with others at the @TheBKP_Official have emphasized and as likely still may be the cleanest path forward.
@TheBKP_Official Hinman also provided lawyers with a set of factors to consider when engaging in a sale, which I will unpack in a separate thread.
@TheBKP_Official In short, we have growing confirmation that tokens sold to investors (and not users) with promises of profits--as in many SAFT and pre-sale agreements—will likely continue to have significant securities law risks.
@TheBKP_Official These tokens may deemed securities and will not automatically convert into commodities when the network is launched or is functional.
@TheBKP_Official Such a possibility will only be seemingly available in limited circumstances when the network is “decentralized” and the transaction involves the sale of the token to other users.
@TheBKP_Official The standard for decentralization, as presented in the speech, seems to center on “[e]ssential efforts” which is a low bar, so most projects that sold tokens to investors likely will still be subject to securities laws.
@TheBKP_Official The cleanest path forward may be to raise financing through traditional means and then distribute/sell tokens to end users. If you’re going to give “investors” tokens, a cloud of securities law concerns will follow.
