Good news for blockchain developers: SEC creates a North Star guide

Editor’s note: Jim Verdonik and Benji Jones recently cofounded Innovate Capital Law. They advise entrepreneurs and investors in capital raising transactions using a tool box of new legal strategies, technology and business practices. 

RALEIGH – Before good navigation tools were developed, ships had to keep sight of land or risk being lost in an endless sea.

America never would have been “discovered” without navigation tools – or the discoverer might have gotten lost and perished on his way home with his discovery remaining a secret he took to the bottom of the sea.

Blockchain software developers and their lawyers have been operating without reliable navigation tools for the past two years since the Securities and Exchange Commission (SEC) announced that coins and tokens are securities.  Last year the SEC announced that maybe all tokens and coins are not securities, but essentially only gave clearance to huge crypto currencies like Bitcoin and Ether.  That left Digital Asset explorers and their lawyers guessing about where the line was between “utility tokens” and securities.

Benji Jones, left, and Jim Verdonik. (Photo courtesy Innovate Capital Law)

Investors hate legal uncertainty.  The SEC’s ambiguous pronouncements that maybe some utility tokens are not securities gave utility tokens that are not securities the same mythical status as unicorns and mermaids – often written about, but never verifiably seen.  That uncertainty made it very difficult for small software developers to raise capital to develop blockchain software that utilizes any kind of token.

Two actions by the SEC’s staff last week create a North Star that will help guide Digital Asset explorers:

We are securities lawyers who focus on capital raising, but this action by the SEC reminds us that the other side of what we and our clients do is just as important as raising capital – our clients have to use that capital to build useful products.  It’s very important to know that your product won’t be deemed to be a security.

We love working on Digital Asset projects because it brings us to the intersection of capital raising and product development.  If the SEC’s rules for Digital Assets are too restrictive, or too ambiguous, or too scary, or too expensive, software developers won’t be able to develop useful Blockchain products that utilize tokens.  What good is a token if securities law prohibits you from spending it?

Both of this week’s SEC actions are positive first steps in a long process of giving software developers guidance about what rules they will have to design into their software.

TurnKey Jet, Inc., a U.S.-based air carrier and air taxi service will now be able to sell its tokens to the public without complying with U.S. securities laws under very specific conditions.  Perhaps more importantly, people who buy the tokens can spend or resell the tokens without complying with “restricted stock” resale rules.

CoinDesk indicates the specific facts presented by TurnKey Jet were under consideration by the SEC for almost a year.  That indicates the SEC’s staff is taking everything related Digital Assets very seriously, because the staff is creating precedents with far reaching consequences for both capital raising and technology.

As you will see in the no-action request letter and SEC staff response letter, TurnKey Jet went to great lengths to design a software platform and a sales effort that ensure that its platform would pass the “reasonable expectation of profit from the efforts of others” part of the Howey test.

Of course, all no-action letters are fact specific.  So compare your project carefully to the specific facts stated in the TurnKey Jet letter before you rely on it.  Better yet, talk to the SEC’s staff through your lawyers and obtain your own no-action letter that will cover your project to give you the type of comfort that investors crave.

The Framework is a more general statement of principles that represent the views of the SEC’s Strategic Hub for Innovation and Financial Technology (“FinHub”). That name is a mouthful, but the name is important, because the name signifies the SEC realizes that its securities rules are defining the course of technology development.  That is a good sign, because it replaces the notion created 2017 that all Digital Assets are fraudulent schemes.

The Framework discusses each of the four prongs of U.S. Supreme Court’s “Howey test” (which determines when tokens, coins and other digital assets will be deemed to be “investment contracts”(and thus a security under U.S. law).  Most of the Framework deals with the issue of when a purchaser of a Digital Asset has a “reasonable expectation of profits (or other financial returns) derived from the efforts of others.”  The Framework provides a bullet point list of over fifty “objective” characteristics software developers and their lawyers should consider.

SEC’s guidance

So, where does the TurnKey Jet no-action letter and the Framework leave the Blockchain community?

No startling new legal principles were announced, but the SEC staff has given us a North Star for software developers and their lawyers.  We now know, with certainty, that “not all tokens are securities” and we have examples of specific software features and business practices that help us pass the Howey test.

We can use this North Star to guide both blockchain software development and discussions with the SEC staff as we push both blockchain software and related capital raising to new frontiers.  Now that we have this navigation tool, investors will have greater confidence that they are not financing a bridge to nowhere when they fund blockchain projects.

We are finally opening the door to begin an exciting journey for all blockchain pioneers and lawyers like us who help guide their way.

© 2019 Innovate Capital Law (Verdonik & Jones, PLLC)

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.

This content was originally published here.

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