SEC Publishes Framework on Security Tokens

The US Securities and Exchange Commission (SEC) published its guidance framework for security token issuance. It describes how security tokens can qualify for a security token offering.

After over a year in the pipeline, the framework details many features that fall under the Howey Test. The US Supreme Court’s Howey Test, a case from 1946, includes four core criteria to determine if a product is a security or, in other words, an investment contract.

The SEC framework essentially details and further elaborates on the primary criteria derived from the Howey Test; in this case, within the context of digital assets.

“The framework is not intended to be an exhaustive overview of the law, but rather, an analytical tool to help market participants assess whether the federal securities laws apply to the offer, sale, or resale of a particular digital asset,” the regulatory agency said in a statement.

“This framework represents staff views and is not a rule, regulation, or statement of the commission. The commission has neither approved nor disapproved its content.”

The SEC further says that the framework applies to entities that facilitate exchanges, store or hold digital assets, offer or distribute digital assets or provide financial management, among others.

In terms of the framework’s objectives, the paper says it aims to protect investors from misinformation from a company and to guide companies in producing complete and accurate information for investors.

“This requirement for disclosure furthers the federal securities laws’ goal of providing investors with the information necessary to make informed investment decisions,” the SEC further notes.

Among the central points of the guidelines, these include the digital asset being exchanged for value, a common enterprise existing (where often investors pool their funds together into this business venture) and that the investor can reasonably expect to make a profit.

Qualification for a digital asset to fall under federal securities laws has a number of additional requirements. First, it notes that the digital asset is fully operational and that investors can immediately use it upon purchase.

“The digital assets’ creation and structure is designed and implemented to meet the needs of its users, rather than to feed speculation as to its value or development of its network,” the SEC says.

For context of virtual currencies, the framework also outlines that it should be readily able to make payments for a number of different items and services. Furthermore, it goes on to say that payment is to be done without having to exchange the virtual currency into another digital asset or fiat currency before making the purchase.

Underpinning these qualifications, the framework further requires that the virtual currency “actually operates as a store of value that can be saved, retrieved, and exchanged for something of value at a later time.”

In order to be compliant with the SEC, some companies are shifting to issuing security tokens instead of initial coin offerings, which operate in grey legal areas. In over two years, security token offering’s (STOs) have jumped from just two offerings in 2017 to 25 offerings most recently in 2018, Bloomberg notes.

STOs are permissible for accredited investors. The laws pertaining to STOs fall under the Securities Act of 1933 and must be in accordance to know your client and anti-money-laundering regulations.

Although the framework is not being a legally binding document, it will serve as a formative guideline for prospective (and existing) token issuers going forward.