SEC Commissioner Hester M. Peirce was awarded the nick name “Crypto Mom” by digital asset aficionados in a previous speech encouraging forward thinking by the SEC in the regulation of tokens and initial coin offerings.
Crypto Mom has now given her view on the application of the Howey test to public token transactions. According to Ms. Pierce, the Howey test is the central tenant of the SEC’s regulatory approach, but blind adherence may not make sense:
While the application of the Howey test seems generally to make sense in this space, we need to tread carefully. Token offerings do not always map perfectly onto traditional securities offerings. . . Functions traditionally completed by people designated as “issuers” or “promoters” under securities laws—which, importantly, bestow those roles with certain responsibilities and potential liabilities—may be performed by a number of unaffiliated people, or by no one at all.
Additionally, I am worried that the application of the test will be overly broad. The Supreme Court in Howey embraced a “flexible rather than static principle, one that is capable of adaptation,” an unwelcome phrase for people craving clarity. The subsequent application of the Supreme Court’s decision has further added to the ambiguity by diluting factors, such as the prong that asks whether the investors were anticipating “profits to come solely from the efforts of others.”[ “Solely” has gotten dropped in the application of this prong. In the years since Howey, many courts have instead focused on whether profits are derived in effect principally from the efforts of others. This approach has been formulated by one appellate court as a question of whether “the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.” More to the point, the Commission itself determined in 2017 that tokens issued by the DAO, a decentralized organization based on a distributed ledger, were securities despite the fact that token-holders had certain roles within the organization necessary to its operation.
Given the role that individuals play in some token environments, either through mining, providing development services, or other tasks, the SEC must take care not to cast the Howey net so wide that it swallows the “efforts of others” prong entirely. In the realm of securities regulation, we often talk of the need for disclosure as a means of addressing information asymmetries between the issuers and the investors. The “efforts of others” prong of Howey aims at the heart of this problem. If the investors are not in control of the enterprise, that is, if they lack material information about the operation of the organization, they will need to obtain that information from those who are in control in order to make an informed investment decision.