The crypto community celebrated a court victory on Jan. 30 when the United States Securities and Exchange Commission (SEC) admitted at the LBRY case remedy hearing that secondary sales of its LBC coin were not security sales. John Deaton, who is representing Ripple in court in the SEC case against it, was so excited that he created a video for his CryptoLawTV channel hosted on Twitter that night.
Deaton, a friend of the court, or amicus curiae, in the case, recounted a conversation he had with the judge that day. "Look, let's not pretend. Aftermarket sales are a problem," then "I mentioned the Lewis Cohen article," Deaton remembered.
Deaton was referring to the article โThe Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are Not Securitiesโ by Lewis Cohen, Gregory Strong, Freeman Lewin, and Sarah Chen of law firm DLx, which Cohen co-founded. Deaton had praised the document before, in November 2022, when it was filed in the Ripple case, in which Cohen is also amicus curiae.
There is a growing buzz around the newspaper. He appeared in the Social Science Research Network preprint repository on December 13. When Cointelegraph spoke to Cohen in mid-January, he said the document was the most downloaded in the securities law category of the website, with 353 downloads after about a month. That number more than doubled in the following two weeks. The document has also garnered the attention of mainstream and legal media and cryptocurrency-related podcasts. Its unusual title is a nod to James Joyce's. Ulises.
Cohen's article takes a close look at one of the timeless adages of crypto securities law: securities are not oranges. This refers to the Howey test, established by the United States Supreme Court in 1946 to identify a value. The article takes a comprehensive look at the Howey test and proposes an alternative to how the test is currently applied.
When Howey met Cohen
Not everyone is in favor of applying the Howey test to crypto assets, often arguing that the test works better to prosecute fraud cases than as a registration aid. the same cohen agreed with this position in a podcast on February 3. However, the authors of the article do not dispute the use of the Howey test, which arose from a case involving orange groves, on crypto assets.
A brief summary cannot come close to capturing the breadth of the article's analyses. The authors discuss SEC policy and cases involving cryptography, relevant precedents, the Securities and Exchange Laws, and blockchain technology in just over 100 pages, plus exhibits. They reviewed 266 federal appellate and Supreme Court decisions, every relevant case they could find, to reach their conclusions. They invite the public to add any other relevant cases to their list on LexHub GitHub.
The Howey test consists of four items often referred to as spikes. Under the test, a transaction is a security if it is (1) an investment of money, (2) in a common enterprise, (3) with the expectation of earning a profit, or (4) derived from the efforts of others. . . All four test conditions must be met, and the test can only be applied retrospectively.
1/ For almost three years, the @DLxLawLLP The team has pondered the biggest question in all of crypto law: When and how do US federal securities laws apply to crypto assets?
โLewis Cohen (@NYcryptolawyer) November 10, 2022
Cohen and his co-authors argue, in a very basic way, that "fungible crypto assets" do not meet the definition of a security, with the rare exception of those that are securities by design. This is the idea captured in the adage about oranges.
The authors of the article go on to say that a crypto asset offering in the primary market may be a low Howey value. However, they note: โTo date, Telegram, Kik, and LBRY are the only fully reported and decided cases involving fundraising cryptocurrency sales.โ
They were referring to the SEC's lawsuit against messaging service Telegram, alleging that its $1.7 billion initial coin offering was an unregistered security offering, which it was decided in favor from the SEC in 2020. The SEC's case against Kik Interactive also concerned token sales and was decided in favor from the SEC in 2020. The SEC also earned their unregistered values sale case against LBRY in 2022.
Related: The Fallout from LBRY: Fallout from the Ongoing Cryptocurrency Regulatory Process
The biggest innovation in the paper is his views on trading crypto assets in secondary markets. The authors argue that the Howey test should again be applied to sales of crypto assets on secondary markets, such as Coinbase or Uniswap. The authors write:
โSecurities regulators in the US have attempted to address the many issues raised by the advent of crypto assets. [โฆ] generally through an application of the Howey test to transactions in these assets. However, [โฆ] regulators have gone beyond current case law to suggest that most fungible crypto assets are themselves 'securities', a position that would give them jurisdiction over almost all activities conducted with these assets.โ
The authors state that crypto assets will, for the most part, not meet Howey's definition in the secondary market. Mere ownership of an asset does not create a "legal relationship between the owner of the token and the entity that implemented the smart contract creating the token or that raised funds from other parties through token sales." Therefore, child transactions do not satisfy Howey's second point, which requires a third party.
The authors conclude, based on their exhaustive study of Howey-related decisions:
"There is no current basis in the law relating to 'investment contracts' to classify most fungible crypto assets as 'securities' when transferred in secondary transactions because there is generally no investment contract transaction."
what does it all mean
The effect of the document's argument is to separate the issuance of a token from a transaction with it in the secondary market. The document says that the creation of a token can be a securities transaction, but subsequent operations will not necessarily be securities operations.
Sean Coughlin, a principal at law firm Bressler, Amery & Ross, told Cointelegraph: "I think it's [Cohenโs] appropriating the fact that emissions [of tokens] they are going to be regulated and he is trying to suggest a way to have it [a token] trade in an unregulated manner.
Coughlin's colleague Christopher Vaughn had reservations that the document was in places "false".
He said: โIt ignores the realities that everyone who has ever traded crypto knows, which is that these liquidity pools and these decentralized exchange transactions don't happen unless the token issuer facilitates them.โ
Vaugh nonetheless praised the document, saying, โI would love for this to be the be all and end all of cryptocurrency.โ
John Montague, a lawyer at Montague Law, which focuses on digital assets, told Cointelegraph that custody issues could complicate Cohen's argument, particularly how self-custody of crypto assets affects Howey's investment side.
Montague acknowledged the high quality of the article's scholarship, calling it:
โThe most monumental piece of thought in the industry regarding securities law perhaps ever, [โฆ] definitely since Hester Peirce's safe harbor proposalโ.
In her final version of the proposal, SEC Commissioner Peirce He suggested Network developers receive a three-year exemption from the federal securities law's registration provisions to "facilitate participation in and development of a functional or decentralized network."
Recent: Crypto and psychedelics: Clarifying regulations could help industries grow
โOne thing I like about the crypto world is that it is contradictory,โ Cohen told Cointelegraph. He said he hoped to "raise the level of discussion" with the newspaper. He did not find much resistance in the responses of the public. However, there have been expressions of cynicism.
โYou are a novelist. You found in crypto a character better explained by the lawโ, a network developer commented On twitter.
โSmart legal opinions rarely move the needle in SEC opinions or compliance cases,โ a financial services executive saying it's LinkedIn.
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