As the cryptocurrency market continues to grow amidst ever-volatile price swings, attorneys and facilitators of the transactions known as “initial coin offerings” (ICOs) are a new target for the Securities and Exchange Commission (SEC). SEC Chairman Jay Clayton is warning so-called “crypto lawyers” that those circumventing federal securities laws could face disbarment or worse. Clayton has instructed SEC staff to be vigilant in addressing legal approaches to ICOs that do not comply with securities laws and the professional obligations of the U.S. securities bar.
The massive expansion of cryptocurrencies has provided a new market—and potential pitfalls—for attorneys. Crypto lawyers and blockchain practices are in high demand due not only to the popularity of cryptocurrency but because of the ambiguity of the industry. As of now, the rules and regulations regarding the exchanges and investments of digital “tokens” are vague—leaving plenty of space for error, intentional or not.
The primary issue perplexing lawmakers and the crypto industry is whether or not ICOs are legally defined as “securities” in the framework of the Securities Act of 1933. The Securities Act was created following the crash of 1929 to protect investors. Using the Supreme Court’s Howey Test, one can determine if certain transactions qualify as “investment contracts.” Those that do are considered securities under the Securities Act.
The statute’s framework requires issuers and sellers of securities to provide investors with the information necessary to make well-informed investment decisions. The Act also prohibits the sale of a security unless it is registered with the SEC.
If the following requirements are met, a transaction will be considered a security:
1. It is an investment of money;
2. There is an expectation of profits from the investment;
3. The investment of money is in a common enterprise;
4. Any profit comes from the efforts of a promoter or third party.
Note that although “money” is used, the Howey Test has been expanded to include other assets.
According to the SEC, based on the test, one should assume that ICOs are “securities.” However, to avoid falling prey to the Howey test, cryptocurrencies can be (and often are) decentralized. In other words, cash with no owner or development team, and therefore, no expectation that a company may profit. For example, the transaction of Bitcoin has not been registered with the SEC, because currently, no one has been identified as responsible for the registration process.
Â The lack of clear legislation allows ICOs to function without regulation, putting crypto lawyers and investors in a vulnerable position.
Clayton stated in his warning to crypto lawyers that when counseling clients on the status of an ICO, some “appear to provide the ‘it depends’ equivocal advice, rather than counseling their clients that the product they are promoting likely is a security.”
To improve the circumstances for attorneys and investors alike, crypto lawyers would benefit from improved transparency in the cryptocurrency market. Sage communications advice and a strategy that supports legal counsel can help merge the seemingly competing interests of cryptocurrency and transparency. After all, part of the appeal of cryptocurrency is in its anonymity and ambiguity.
Â A proactive approach includes assisting crypto lawyers as they work with their clients and lawmakers to develop a solid legal foundation and set of regulations for the cryptocurrency market—while also managing the client’s reputational risk through the process. Improving transparency does not mean giving up the very ideals that make cryptocurrency so revolutionary. It simply means correcting the misunderstandings about cryptocurrency and doing so on your own terms—not that of a regulator or litigator. Being proactively transparent will protect cryptocurrency’s appeal, not harm it.
The prosperity of the cryptocurrency market will increase the need for more advisors and legal counsel. A transparent and more proactive approach could settle the SEC, inform the general public, and reassure investors. Attorneys who take the necessary steps to clearly communicate externally during this uncertain period will have a jump start on defining their role or specialty in the cryptocurrency market. They will also be protecting their clients in the court of public opinion, before any further regulation or litigation.
As it stands, crypto lawyers and their clients risk being at the mercy of an uninformed narrative.
LEVICK Fellow Caroline Beckmann contributed to this post.