SEC Says Stablecoins not Subject to Securities Laws
Commentary by Andrew Lom and Steven Lofchie
After undertaking a legal analysis, the SEC Division of Corporation Finance ("Division") concluded "that the offer and sale of Covered Stablecoins, ... do not involve the offer and sale of securities within the meaning of [the Securities Act or the Exchange Act]."
In a public statement, the Division said it applied the four-factor "family resemblance" test set forth by the Supreme Court in Reves v. Ernst & Young to determine whether Stablecoins are securities, as they share "some characteristics with a note." Under Reves, a note is presumed to be a security unless it closely resembles a "typical commercial transaction," a presumption that can be rebutted. A Reves analysis considers: (i) the motivations of the seller and buyer; (ii) the plan of distribution of the instrument; (iii) the reasonable expectations of the investing public; and (iv) risk-reducing features. Federal courts apply the Reves test as a balancing analysis, weighing all four factors together to determine whether a note qualifies as a security.
After weighing these factors, the Division concluded that "Stablecoins are not securities." The Division emphasized that Issuers use the funds from Stablecoin sales to support a Reserve, while purchasers are "not motivated by an expected return on their funds." It acknowledged that while Covered Stablecoins are offered broadly, their "price stability" and "one-for-one" redemption structure minimize speculative trading. The Division also highlighted that Stablecoins are marketed solely as a means of payment or value storage, not for profit. Lastly, it found that Covered Stablecoins are backed by a fully funded Reserve of low-risk, liquid assets to meet all redemption demands.
The Division considered when a Covered Stablecoin is "not viewed as a note or other debt instrument." The Division analyzed the "economic realities" of Stablecoins under the "'investment contract' test set forth in" SEC v. W.J. Howey Co., to determine whether money was invested with "a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others." The Division concluded that Covered Stablecoins do not meet this standard, as purchasers are not motivated by profit, but by the functional use of the Stablecoin in transactions.
SEC Commissioner Caroline A. Crenshaw criticized the Division's public statement, arguing it relies on flawed assumptions and misrepresents key facts about the USD-Stablecoin market. Ms. Crenshaw questioned the staff's reliance on issuer-led risk mitigation, noting that most retail holders access Stablecoins through intermediaries with no obligation to redeem at par or ensure rights to the issuer's reserve. She emphasized that the issuer reserves do not "collateralize" retail-held Stablecoins and fail to offer the protections required under Reves. She warned that by overlooking the central role of intermediaries and the opacity of reserve practices, the staff's statement promotes a false sense of the "supposed stability and safety" of Stablecoins.
Commentary
Stablecoins are supposed to be stable, and it is an acknowledged problem if and when they're not. However, if the primary purpose (indeed sole purpose) of stablecoins really is to store value and facilitate payments, and emphatically not to seek to generate returns, then it makes sense that stablecoins are not securities, even if they may have certain risks that may be similar to securities risks. There are plenty of other risky things people can buy, hold, sell, lose or discover to be worthless. There are also plenty of other federal and state regulators capable of addressing the risks of those other things. Not everything that has risk is a security or needs the SEC to be its gatekeeper.
Commentary
Ruling that stablecoins are not securities is consistent with not only the Howey test, but also the very limited favorable interpretive advice previously issued by the SEC as to digital assets. (See, e.g. Framework for "Investment Contract" Analysis of Digital Assets—"The U.S. Supreme Court's Howey case and subsequent case law found that an 'investment contract' exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.").
That Commissioner Crenshaw asserts that stablecoins are securities even when they would not meet the Howey test, suggests that the Commissioner's position is not based on "law," but on policy, or preference or politics. Her concerns that stablecoins have risk if wholly unregulated is not wrong; but "risk" alone is not sufficient to meet the Howey test—the standard on which the SEC has supposedly relied in analyzing digital assets status as securities. However well-intentioned Commissioner Crenshaw's preferences may be, the expression of such preferences unsupported by legal basis is not appropriate for a regulator; it is for the legislators. Now it will be up to Congress to move forward with legislation, if the legislators think appropriate.
It is notable that the Division did not restrict its statement to stablecoins backed by USD; other "low risk" assets were also permitted backing.
Related Articles
-
The SEC Division of Corporation Finance stated that it would not regard "Protocol Mining" as involving "the offer and sale of securities."
