The Securities and Exchange Commission’s Division of Corporation Finance issued a no-action letter saying that a digital token designed to facilitate access to a multitude of online video games would not be required to be registered as an equity security. The NAL was sought by Pocketful of Quarters, Inc. (“POQ”) for its proposed “Quarters” digital coin. POQ proposes to introduce a Quarters platform that will leverage blockchain technology to allow gamers to access participating video games and enter hosted tournaments using Quarters which it hopes to evolve into a universal gaming token.

Corp Fin said it granted no action to POQ because, among other reasons, (1) the firm would not use funds from Quarters’ sales to develop the Quarters’ platform; (2) Quarters would be immediately usable at the time they were sold; (3) gamers would only be able to transfer Quarters for gameplay to developers with approved accounts or to POQ for tournaments; (4) only developers and so-called “influencers” with approved accounts would be permitted to exchange Quarters for the virtual currency “ether” at predetermined exchange rates; (5) Quarters would be made available in unlimited quantities and fixed prices; and (6) the purchase price of Quarters would correspond to the market price of accessing and playing participating games. Additionally, Quarters would be marketed solely for consumptive use and as a means to access participating games and not as an investment.

According to the NAL request submitted by POQ, Quarters would not constitute investment contracts (and thus securities) under the 1946 Supreme Court decision SEC v. W.J. Howey principally because “no gamer will be motivated to purchase Quarters by any reasonable expectation of profits.” The SEC has previously relied on the four prongs derived from Howey to assess whether a digital asset might be an investment contract and be subject to applicable securities laws (i.e., (1) an investment of money, (2) in a common enterprise with (3) the expectation of profits (4) from the efforts of a promoter or third party. (Click here to access the Howey decision.)

In other legal and regulatory developments involving cryptoassets:

  • Bitfinex and Related Companies Answer NY AG Complaint by Saying They Had No NY Connections: Bitfinex and related companies moved to dismiss the special proceeding commenced by the New York Attorney General against them earlier this year, claiming that respondents have for some time barred US persons from their platforms, and thus they are not subject to lawsuit by the NY AG. In April 2019, the NY AG obtained an ex parte order from a New York State court prohibiting companies associated with Bitfinex as well as the stablecoin “tether” from accessing, loaning or encumbering in any way US dollar reserves supporting tether digital coins. Respondents also argued that tether is neither a security nor a commodity and thus not subject to the relevant law the NY AG sued them under. (Click here to access the most relevant provision of the Martin Act. Click here to access background regarding the NY AG’s initial lawsuit in the article “NY Attorney General Sues Stablecoin Issuer and Related Companies for Purportedly Misusing Tethered Fiat Currency Without Customer Disclosure” in the April 28, 2019 edition of Bridging the Week.)  
  • IRS Begins Reminding Individual Taxpayers of Virtual Currency Transactions Tax Payment Obligations: The United States Internal Revenue Service announced it has begun sending letters to US taxpayers reminding them of their obligations to pay taxes on transactions involving virtual currencies no matter where they occurred  The IRS noted that persons who do not meet their tax obligations on a timely basis could be subject to fines and interest in addition to the amount of taxes, and in some circumstances, criminal prosecution. The IRS previously has said that virtual currencies are property for federal tax purposes (click here for IRS Notice 2014-21).  
  • NYS DFS Moves Licensing of Virtual Currency Companies to New Research and Innovation Division: The New York Department of Financial Services placed the former division responsible for licensing and overseeing virtual currency activity in a new division named the “Research and Innovation Division.” The new section will also “assess new efforts to use technology to address financial exclusion, identify and protect consumer data rights, and encourage innovation in the financial services marketplace.” Presumably, the new section will oversee issuance of so-called BitLicenses. (Click here for background regarding New York’s BitLicense requirements in the article “New York BitLicense Regulations Virtually Certain to Significantly Impact Transactions in Virtual Currencies” in a July 8, 2015 Advisory by Katten Muchin Rosenman, LLP.)  
  • Facebook Agrees to Settle FTC and SEC Charges Related to Data Use for US $5.1 Billion Fine: Less than two months after announcing its Libra stablecoin initiative, Facebook settled charges filed on behalf of the Federal Trading Commission and by the Securities and Exchange Commission related to customers’ data use. In a legal action brought by the Consumer Protection Branch of the US Department of Justice on behalf of the FTC, Facebook agreed to pay a US $5 billion fine and to establish a privacy committee of the firm’s board of directors and appoint compliance officers to be responsible for Facebook’s privacy program in order to settle charges that, at various times from 2010 through at least June 2018, it misled users regarding their ability to control the use of their personal information through privacy settings. Separately, Facebook agreed to pay US $100 million to the SEC for advising investors from 2016 until mid-March 2018 about the potential misuse of users’ personal data in theoretical terms, when in fact Facebook was aware since December 2015 that a company employee had improperly sold information of “tens of millions of Facebook users” to Cambridge Analytics, a data analytics firm. Facebook made such disclosures, charged the SEC, in risk factor disclosures in public filings. (Click here for background regarding Facebook's Libra initiative in the My View commentary t0 the article "Global AML Standards Setter Says Countries Should Require Virtual Asset Service Providers to Obtain and Transmit Certain Information Regarding Senders and Recipients for All Virtual Asset Transfers” in the June 23, 2019 edition of Bridging the Week.)  
  • Canada OSC Settles With Company for Trading Cryptosecurities Without License: CoinLaunch Corp., a Canadian company, agreed to pay a fine, disgorgement and costs totaling over CAN $50,000 to the Ontario Securities Commission for facilitating the offering of two digital tokens that constituted securities, without registering to be in the business of trading securities, as required, under Ontario law. CoinLaunch marketed itself as a crypto consulting firm that helped companies administer digital token offerings, solicit potential investors, and find seed funding for token offerings.

Legal Weeds: Previously, SEC Corp Fin indicated it would not recommend an enforcement action against TurnKey Jet, Inc. for issuing a digital asset to facilitate sales of air charter services without registering the token as a security under applicable law. 

According to a description written by TurnKey, the digital token, as proposed, would effectively be a stablecoin offered in increments of US $1 that would effectuate easier payment for air charter services by potential users to air charter providers (including potentially TurnKey) and intermediary brokers. All transactions would occur solely among subscribers to TurnKey’s membership program utilizing the firm’s fully developed permissioned blockchain and smart contract technology. Proceeds from token purchases would be deposited in escrow accounts maintained at FDIC-insured US banks. Users could only use the tokens on the TurnKey network. Tokens might be repurchased by TurnKey but ordinarily only at a discount to face value. As a result, tokens might also be bought and sold among members, but there would be no “incentive to buy from other Token holders at a premium above one dollar per Token.” 

TurnKey itself would solely fund the development and operation of its network (and not use any proceeds from token purchases) and would charge membership fees to users, providers and brokers. TurnKey would market the tokens for their functionality and not as an investment. (Click here for a copy of the TurnKey NAL.)

Although both the TurnKey and Quarters NALs provide valuable insight into what indicia Corp Fin believes would not cause an asset to be regarded as an investment contract (and thus a security), the fact patterns hardly seem controversial. A stablecoin backed 100 percent by one fiat currency and an admission token to arcade games do not seem the type of instruments that could reasonably be deemed securities. Although SEC staff is applauded for taking small steps to not interfere with the development of legitimate blockchain technology applications, some bigger, more insightful leaps are hopefully forthcoming.