What Does SEC’s Statement On Bitcoin Mean For Investors?

U.S. Securities and Exchange Commission (SEC) officials have stated that Bitcoin is not a security.^[1] Many digital currency enthusiasts have reacted positively to this development, but what are the implications of this statement? This article will explore the consequences of the SEC's decision.

The Howey Test

To understand SEC Chair Jay Clayton's statement that Bitcoin is not a security, it is helpful to have some background on the Howey Test, which was developed to determine whether a certain transaction counts as an "investment contract."^[2]

Clayton simplified the Howey Test by saying that if an investor points money toward a business venture with the expectation that he or she will receive a return, then it is a security.^[1] As a result, when companies sell digital tokens to investors to fund a particular venture, based on the idea that investors will get a return either through these tokens rising in value or through their price climbing on the secondary market, that is a security.

However, he said that digital currencies like Bitcoin, which seek to replace fiat currencies like the British pound and Japanese yen, are not securities.^[1]

Bitcoin's Exemption From Securities Laws

One major implication of the SEC declaring that Bitcoin is not a security is that the digital currency is not subject to securities laws. As a result, Bitcoin does not need to be registered with the government agency.^[3] (123)

Registration must be completed by a company and it involves disclosing key information regarding the business entity issuing the securities in addition to important details on the securities themselves.^[3]

William Hinman, director of the SEC's Division of Corporation Finance, stated in June 2018 that imposing "the disclosure regime of the federal securities laws" on to Bitcoin would probably not provide much benefit.^[4]

Exemption From Rule 10b

Another significant implication of this declaration is that investors in the digital currency are unable to leverage Rule 10b, which helps protect investors by allowing them to bring suit against parties accused of violating securities laws.^[5]

One part of Rule 10b, specifically Rule 10b-5, prohibits individuals engaged in securities transactions from defrauding others, making material statements that are not true or omitting material facts.^[6]

Investors are able to recover billions of pounds worth of their losses every year through securities litigation,^[7] so losing the ability to take this legal action eliminates an important investor protection.

SEC Lacks Jurisdiction Over Bitcoin

The SEC has the authority to investigate securities transactions and take legal action against those involved. Given that Bitcoin is not a security, the government agency lacks jurisdiction over the digital currency. In other words, it lacks the authority to scrutinise Bitcoin transactions and take action if needed.

Role Of CFTC

While the SEC lacks jurisdiction over Bitcoin, the U.S. Commodity Futures Trading Commission (CFTC) still has authority over digital currencies. The CFTC affirmed its authority in this space in 2015 when taking action against Coinflip Inc., an unregistered Bitcoin options trading platform. This confirmed that the digital currency qualified as a commodity under the Commodity Exchange Act (CEA).^[8]

A 2018 court case supported the CFTC's authority to regulate digital currencies, stating that the government agency has the ability to define them as commodities.^[9] "Virtual currencies can be regulated by CFTC as a commodity," according to the ruling.^[10] "Virtual currencies are 'goods' exchanged in a market for a uniform quality and value."

"They fall well within the common definition of 'commodity' as well as the CEA's definition of 'commodities' as 'all other goods and articles . . . in which contracts for future delivery are presently or in the future dealt in,'" the ruling continued.^[10]

FINRA

The Financial Industry Regulatory Authority (FINRA), which is a nonprofit authorised by Congress, is another organisation with Bitcoin oversight.^[11] It regulates broker-dealers and also provides investors with information so they can make well-informed decisions.

FINRA released a warning to investors in December 2017 that provided tips and tricks so they could avoid falling victim to stock scams involving digital currency-related claims.

Gerri Walsh, FINRA's senior vice president for Investor Education, emphasized the appealing nature of these digital assets in a statement. "It can be difficult for investors to avoid the lure of the cryptocurrency markets, especially when prominent people express interest in it," Walsh said. "and news reports and social media tout the promise of guaranteed quick fortunes and skyrocketing returns."

"But it is important to do your research. Even when legitimate companies enter a hot, new sector, con artists almost always follow suit," he added.

In April 2018, FINRA took action against Arthur Breitman and fined him US$20,000 to settle allegations that he failed to provide written notice to Morgan Stanley while he worked on a digital currency named Tezos.^[13] Securities professionals are obligated to inform their employers in writing of outside business activities if a "reasonable expectation of compensation" exists.

Summary

With the SEC's statement that Bitcoin is not a security, investors in the digital asset have been deprived of securities litigation, which they could otherwise use to remunerate themselves in the event of securities fraud or other violations of securities laws.

Now that the SEC has specified it lacks jurisdiction over Bitcoin, investors have received key information on the regulations surrounding the digital currency. While the SEC lacks authority over Bitcoin, the CFTC has jurisdiction over this digital asset, confirming this through actions it has taken and rulings within the judicial system.