Will the SEC-Kik Case Clarify the Law?
The Blockchain Association has long sought a US legal framework that is clear and that appropriately supports open blockchain innovation. Other nations are taking the lead in supporting public policy that nurtures this technology. Unfortunately, the US has been slower to respond.
There are several pathways to public policy change, including the regulatory and legislative processes. We are excited that forward-looking leaders in Congress have introduced the Token Taxonomy Act in an effort to get the clarity that innovators need. But policy change can sometimes come from the courts. The SEC-Kik case is the first major case involving the application of securities laws to a cryptocurrency, and the industry will be watching it closely.
Some analysts reviewed the SEC’s complaint against Kik and concluded that the case is just a matter of applying clear law to murky facts. The law, however, is extremely difficult to apply to this new technology. Depending on which direction this case goes, we might get more clarity or we might not.
The law is not clear
Let’s begin with a very basic fact: cryptocurrency law is completely unsettled. Industry participants and the SEC are trying to divine how courts might apply a test from a 73-year-old case involving orange groves. Until the Supreme Court, an appellate court, or Congress weighs in, we lack binding clarity.
The SEC has not tested a cryptocurrency regulation in court nor has it adopted or proposed a regulation. An SEC division director gave a major speech last year but explicitly stated that the speech did “not necessarily reflect [the views] of the Commission, the Commissioners or other members of the staff.” After that, the SEC Division of Corporation Finance and the Division of Trading and Markets issued a 60 plus factor “framework” that is “not binding,” “represents Staff views and is not a rule, regulation, or statement of the Commission,” and has been “neither approved nor disapproved.” So there is no SEC regulation that a court has reviewed and no finality from decided cases regarding specific sales. Settlements, even SEC settlements, have no precedential value. Neither do district court decisions (unlike appellate decisions), and the district court cases are still in the preliminary stages. There is no clear precedential law on the sale of cryptocurrencies.
The non-binding speeches and frameworks issued by SEC officials will receive almost no deference in court, and rightly so. Usually courts give agencies like the SEC extensive deference: for example, when there are multiple reasonable interpretations of the law, courts don’t require agencies like the SEC to pick the very best interpretation. Rather, they “defer” to the agency to pick any of the reasonable interpretations (this is called Chevron deference, after the Supreme Court decision that articulated this rule). But this deference applies to binding agency rules, passed according to the Administrative Procedure Act (APA), not to “opinion letters” — like interpretations contained in policy statements, agency manuals, and enforcement guidelines.” So the courts will only defer to the SEC’s existing framework and legal arguments based on their power to persuade through reasoning. If the SEC has not chosen the very best legal interpretation, a court may disregard the SEC’s views and choose the best interpretation itself.
We have seen federal agencies and courts struggle to apply existing laws to other new technologies before. Is a thumbnail image on Google search a violation of (centuries-old) copyright law? Is Airbnb an unlawful hotel service? Is Uber an unlicensed taxi service? Is providing Internet access a “telecommunications” or “information” service? In the first notable Supreme Court decision about the Internet in 1997, the Supreme Court considered the appropriate legal standards by debating whether the Internet was more like a broadcast station, a shopping mall, a soapbox, or a newspaper. One reporter at the time called the oral argument “nine justices in search of a metaphor.” Applying the right metaphors, principles, and precedents to new technologies is not straightforward: new technologies may straddle multiple metaphors, principles, and precedents.
We have no idea if the courts will reach conclusions similar to the SEC’s non-binding staff guidance. The courts could conclude that functionality or consumptive use is what matters, not decentralization.
One potential outcome: the Kik case does not clarify the law
If the law is unclear, how could the SEC-Kik case clarify it? The SEC’s complaint is extremely narrow. It does not argue that Kin sales today are security sales (leaving that question open), only that Kin’s initial sales in 2017 were sales of securities. Further, if the court accepts the SEC’s version of the facts, it won’t even need to decide among pre-functional, functional, or decentralized tokens, so the key question for the whole industry will remain unclarified.
Under the SEC’s argument, the court decision would simply advance one obscure area of law dealing with “integration” of offerings. The crux of the SEC’s complaint is that Kik sold an admitted security (the Kin SAFTs) and the Kin tokens in the same transaction, not two separate transactions. If the two sales were one integrated sale, then any statements about investment potential made in connection with SAFT securities sales would apply also to the Kin token sales, which would then more likely be securities sales. Kik’s lawyers will likely argue that the two sales were separate. So we might end up with new case law on integration of offerings, and not much else.
Another potential outcome: This case could clarify the law
The court decision may follow a different path. If the court finds that the SAFT and token sales here were not integrated, then the court has to answer separate questions. It would turn to deciding whether Kin token sales were non-securities sales. Kik has already signaled that it will aggressively challenge the SEC’s interpretation of every part of the Supreme Court’s relevant test, writing in a press release:
The complaint assumes, incorrectly, that any discussion of a potential increase in value of an asset is the same as offering or promising profits solely from the efforts of another; that having aligned incentives is the same as creating a ‘common enterprise’; and that any contributions by a seller or promoter are necessarily the ‘essential’ managerial or entrepreneurial efforts required to create an investment contract.
Since the SEC receives no deference from courts regarding the interpretation of Supreme Court decisions, the court very well may reach a different conclusion than the SEC complaint on some or all of these points.
The SEC complaint doesn’t neatly tee up these issues, but Kik will make these arguments — as will allies, who file in court as “intervenors” or “amici.” If the court entertains any of these arguments, the industry could receive considerable guidance.
So let’s not assume that judges will mirror the SEC’s non-binding speeches and staff assertions. The court’s legal decisions — though they could be years away — may help pull us out of this uncertainty.