On March 22, 2023, the Securities and Exchange Commission (“SEC”) filed a complaint against Justin Sun and his related companies, which included claims that he made offers and sales of unregistered securities.[1] According to the complaint, Sun distributed two crypto tokens, TRX and BTT, which the SEC claims are unregistered securities. Unlike most prior actions alleging that tokens were sold for cash or other cryptocurrency, the SEC alleged that some of the tokens were distributed by Sun to users in exchange for completing certain tasks, such as promoting the tokens on social media. [2] The SEC argues that these distributions qualify as “investments of money,” one of the requirements to prove the existence of an investment contract under the Howey test. However, there are reasons to believe that the SEC is wrong given the legal meaning of “investment” in the context of Howey.
The Non-Monetary Distributions
In the Sun complaint, the SEC alleges that 11 different distributions of TRX and BTT tokens in return for consideration other than cash or cryptocurrency were investments. Many of these distributions (also called “bounties” by the SEC) were in return for interactions on social media, such as:
- Telling a story about the tokens’ ecosystem with emojis on Twitter or Facebook while using a certain hashtag for a chance to win TRX (the “emoji contest”);
- Retweeting and commenting on tweets announcing the emoji contest with a certain hashtag for a chance to win TRX; and
- Following BitTorrent on Twitter, visiting a YouTube page, and explaining why they want to use BitTorrent in a social media post for a chance to win BTT.
The SEC clarified its intent to label these investments of money by stating: “All purchasers, including those who tendered value for TRX other than cash or crypto assets, invested in a common enterprise. . . .”[3] While this is not the first time the SEC has made similar allegations, the Sun complaint appears to be the broadest application to date.[4]
Analysis
The “investment of money” prong in Howey is often overlooked by many, including the SEC, with an assumption that any exchange of money for the asset qualifies. However, as the defendants and various amici make clear in the Ripple summary judgment briefing, one cannot ignore the core question being examined by the Howey test: whether there was an investment contract. In that context, we must distinguish a payment from an investment. An investor must “commit his assets to the enterprise” for this essential prong to be met. Warfield v. Alaniz, 569 F.3d 1015, 1021 (9th Cir. 2009). Additionally, for an investment to exist, as opposed to a payment, the buyer must “subject himself to [a risk of] financial loss.”[5] Within this legal framework, even secondary market transactions are unlikely to be an investment of money under Howey, since they involve one stranger paying another stranger, with no money going into any enterprise.
When examining the distributions in the Sun complaint under this framework, it is hard to see how many of the incentivized behaviors could qualify as investments in Sun’s enterprises. The tasks are very distinguishable from any investment of “sweat equity” because the tokens do not grant any ownership rights in the Sun enterprises and many of the tasks were completed with only a chance for tokens to be awarded. Because they didn’t gain equity, no one receiving tokens from the Sun bounties could expect any profits from the Sun enterprises they made social media posts about. Additionally, the financial risk to drafting and posting a Tweet is likely to be near zero (unless you are someone like Elon Musk). The same lack of financial risk goes for most of the other tasks as well.
Conclusion
Token projects with free distributions to users for past or future utilizations of their platform or for the performance of specific tasks should be cognizant of the SEC’s expanding stance on investment of money. Here, the point may be moot since the Sun ICO sales are more likely to qualify as investments. But for other projects without direct sales (or with exempted sales), the core considerations of Howey provide plenty of reason to vigorously refute the SEC’s claim that incentivized behaviors qualify as an “investment of money.”[6]
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For more discussion and analysis of developments regarding enforcement actions see our other posts:
- SEC’s Inaction Against Most Initial Coin Offerings Sends More Mixed Messages on Crypto Enforcement
- New DOJ and SEC Insider Trading Actions Fail to Clarify Issue of Digital Assets as Securities
- Will DOJ’s First Ever Digital Asset Insider Trading Case Stick?
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[1] SEC Press Release No. 2023-59, SEC Charges Crypto Entrepreneur Justin Sun and his Companies for Fraud and Other Securities Law Violations, (March 22, 2022), https://www.sec.gov/news/press-release/2023-59.
[2] Id.
[3] Id. (emphasis added).
[4] In a September 29, 2022 complaint, the SEC alleged that marketing tasks with specific, assigned token distributions were an investment of money. See SEC Complaint, SEC v. Hydrogen Tech. Corp., Case 22-cv-08284 (2022), https://www.sec.gov/litigation/complaints/2022/comp25553.pdf. And, in an August 14, 2018 Order, the SEC claimed distributions of a token in return for marketing tasks incentivized by a bounty program qualified as “sales” of a security. See SEC Order, SEC v. Tomahawk Exploration LLC, File No. 3-18641 (2018), https://www.sec.gov/litigation/admin/2018/33-10530.pdf.
[5] See also SEC v. Rubera, 350 F.3d 1084, 1090 (9th Cir. 2003); Payton v. Flynn, 2006 WL 3087075, at *7 (N.D. Ill. Oct. 26, 2006); Conde v. SLS W., LLC, 2005 WL 1661747, at *7 (S.D. Ind. July 15, 2005); SEC v. Friendly Power Co., 49 F. Supp. 2d 1363, 1368-69 (S.D. Fla. 1999).
[6] Many have compared incentivized distribution of tokens to the SEC’s “free stock” cases, but, as pointed out by Lewis Cohen, those cases involved the receipt of stocks, securities on their face, and the question was whether they were “sold,” not whether there was an “investment of money.” Lewis Cohen, Twitter, https://twitter.com/NYcryptolawyer/status/1568327307416276994. Since an investment of money must exist in order for something to qualify as a security, the investment of money analysis comes before the questions of whether a security was sold.
