On June 29, 2021, a major cryptocurrency exchange (the “Crypto Exchange”) announced a new program called “Lend” in which it proposed offering customers a 4% interest rate on cryptocurrency tied to USD.[1] But on September 7, 2021, the Crypto Exchange announced that the U.S. Securities and Exchange Commission (the “SEC”) had issued a Wells notice, a formal notice that the agency was planning to sue them for offering the program.[2] While the Crypto Exchange took the position that it was unclear why the SEC had issued this notice, it was evident from public comments that the SEC had been contemplating whether investment cryptocurrency programs should be classified as securities.[3] On September 20, 2022, the Crypto Exchange announced that it was dropping its Lend program.
This post will discuss the two cases that the SEC relied on as the basis for issuing its Wells Notice to the Crypto Exchange, as well as the future for these types of programs.
Background
Federal law defines a security extremely broadly, including notes, stocks, investment contracts, and even fractional undivided interests in oil, gas, or other mineral rights.[4] Any public offers or sales of securities must be registered with the proper authorities.
The Crypto Exchange’s Lend program was advertised as a “high-yield alternative to traditional savings accounts” and offered 4% interest on a USD Coin (“USDC”), which was a “stablecoin that [could] always be redeemed one-to-one for USD $1.00.”[5] Customers could purchase USDC with money, lend the USDC to the Crypto Exchange, and earn 4% interest on the coin. the Crypto Exchange was not alone in offering this type of product; at the time, multiple lending platforms offered similar interest account offerings.[6]
The SEC accused the Crypto Exchange’s Lend program of offering an unregistered sale of securities thereby violating registration requirements. The SEC saw the Crypto Exchange’s Lend program as both an investment contract and a note, classifications that would bring the Lend program under the purview of federal securities law. In doing so, the SEC relied on two Supreme Court cases: S.E.C. v. Howey, for determining if a product is an investment contract, and Reves v. E&Y, for determining if a product is a note.
S.E.C. v. Howey, a decision from 1946, involved land sales and service contracts for citrus groves in Florida, but more importantly, set out a three-prong test for defining an investment contract.[7] Under the eponymous Howey test, an investment contract is “a contract, transaction or scheme whereby a person [1] invests his money in [2] a common enterprise and [3] is led to expect profits solely from the efforts of the promoter or a third party . . . .”[8]
Reves v. E&Y, a decision from 1990 about a farmer’s cooperative and an accounting firm, established “a presumption that every note is a security,” but also noted that this presumption could be rebutted if the note bore a “family resemblance” to excepted categories.[9] In order to provide more guidance, the Court established “the family resemblance test” to determine whether a note is a security.[10] The Court set out four factors to assess when evaluating a note: [1] the motivations of the seller and the buyer, i.e. whether the seller is looking to raise money and the buyer is looking to profit, [2] the plan of distribution and whether it involves common trading for speculation or investment, [3] the reasonable expectations of the investing public, and [4] whether there is another regulatory scheme that would render the application of the Securities Acts unnecessary.[11]
In a speech on August 3, 2021, SEC Chairman Gary …….
Source: https://www.jdsupra.com/legalnews/the-sec-begins-regulation-of-7914622/