The so-called Howey test, which the SEC uses to determine whether a digital asset should be classified as a security, says SEC Commissioner Hester Pearce has some limitations.
The test derives from a landmark Supreme Court case decided in 1946, which established the criteria by which a financial agreement qualifies as an “investment contract” and is therefore subject to federal securities laws.
Regarding cryptocurrency, Peirce explained why testing is so important to the industry.
“There has been a lot of focus on Howey testing in the crypto world since then […] A lot of this stuff was sold as tokens as well as a promise that we would build a network,” she said on the latest episode of Decodes gm! Podcast.
The lawsuit that led to the creation of Howey’s Test revolved around the sale of units in a Florida citrus grove where investors could share in the profits from product development efforts.
the determined An “investment contract” is “a contract, deal or scheme whereby a person invests his money in a joint venture and is led to expect profits solely from the efforts of the promoter or a third party.”
In August, Securities and Exchange Commission Chairman Gary Gensler He said “Many of the tokens could be unregistered securities” because “the people who buy these tokens expect profits, and there is a small group of entrepreneurs and technologists standing by and sponsoring the projects.”
Peirce argued that the existence of an investment contract relates not only to the asset but also to the promises associated with it. She was of the view that the two components were separate from each other.
“Just because I sold you the orange grove as part of an investment contract doesn’t turn the orange grove into insurance,” she said. “The orange grove, plus the promises I made to you about how the orange grove will be run and make profits for you — that was the stock offering.”
Whether it’s a crypto asset or not, security wasn’t addressed by the Howey test, Pearce said.
“You can say, ‘Okay, look, a lot of these initial sales really look like security offerings,’ but then the question is, is it token, is the crypto asset itself a security?” she asked. “That’s a much harder question, and I think it’s one that people answer differently.”
The agency’s reliance on the Howey test is somewhat flawed, Peirce said, because of the apparent continuity of interpretation.
In 2018, William Hinman, director of the SEC’s corporate finance division, said he believed Bitcoin and Ethereum were not securities because they had become “decentralized enough,” a limit not set by the Howey test.
“We said the orange grove would be treated as collateral forever,” she said. “I don’t know when this will stop being a security, and it doesn’t make any sense.”
Explaining how a digital token can move from being considered a security to a commodity, Pierce said, would address some of the criticisms players in the crypto space have with the SEC’s regulatory approach.
“If we’re being more precise, I think there would be less objection to Howey’s test application and saying, ‘Hey, the first time I sold it, it might have been a stock offering,’ but that doesn’t mean the token continues to be a security for the rest of its life,” she said.
Whether or not specific digital assets count as collateral is largely a matter Gensler raises on the toes All around since his appointment as Chairman of the Securities and Exchange Commission. Gensler has only said publicly that Bitcoin is not a security and declined to comment on other coins.
“There’s a lot out there about whether something is certain, and that’s why we need to clear this up,” Pearce said.
Since Pierce joined the SEC in 2018, she said there has been no “real positive movement” on cryptocurrency regulation despite many conversations and efforts to better understand the technology, and called the lack of progress frustrating. She also said that government inaction affects how people operate in the crypto space.
“The wheel of regulation and legislation moves very slowly, and I think that can be both good and bad,” she said. “In the cryptocurrency world, we’ve seen for a long time that there is a lack of clarity, which I think has caused people to do things they wouldn’t have done if there were clear guidelines.”
Pierce explained that she wasn’t specifically thinking about cryptocurrencies when she became part of the SEC, but was gradually drawn to the technology as part of a focus on how the SEC can facilitate or hinder innovation.
“I think it’s great for people to challenge the way we’ve done things; sometimes those challenges will fail and sometimes they will succeed.” “But we just need to make sure that it’s not the regulations that pick the winners and the losers — it’s the people who pick the winners and losers.”
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