Subscribers to our blog know that we monitor EDGAR for new SEC comment letters and enjoy bringing attention to the more interesting ones. In today’s blog post, we bring your attention to a recent SEC comment letter exchange where the registrant (a trust) was asked to provide a legal analysis that a specific digital asset (in this case, ZEN) was not a “security” under Section 2(a)(1) of the Securities Act. In response to the comment, the letter attached as an exhibit a memorandum of counsel analyzing ZEN under the federal securities laws.
The memo provides that because ZEN does not possess features of traditional categories of securities (e.g., a “stock” or a “note”), the sponsor of the trust has relied upon the Supreme Court’s test for an “investment contract” under SEC v. W.J. Howey Co., and then walks through the Howey analysis as applied to the facts of ZEN.
The memo concludes as follows:
“The SEC could claim that ZEN is a security on the basis that holders would rely on the efforts of the Foundation or the Company. Even so, while not free from doubt, the Sponsor could make arguments to the contrary that, in light of the full facts and circumstances, ZEN does not meet all the elements of Howey such that it would be an investment contract.
In particular (i) ZEN and its predecessor asset were and are generated entirely through mining – there was no [initial coin offering] or other capital raising event; (ii) ZEN was fully functional when launched and remains functional – ZEN is not an asset used solely to speculate on future functionality; (iii) ZEN has actual real-world usage and utility, as a payment instrument and secured messaging platform; (iv) ZEN has not been marketed as an investment, and has actual existing utility and usage; and (v) while the Foundation and Company play a role in the development of the network, there is no assurance of their continued involvement in the project – actual control of the network belongs to a distributed group of miners and users, each of which can elect whether to accept any changes to the network code. These facts could be used by the Sponsor to argue that there has not been any investment of money, that holders of ZEC should not reasonably expect profits, but instead hold ZEN for consumptive purposes, and that, even if ZEN holders were to expect any profits, it would not be reasonable for ZEN holders to rely on the efforts of an identifiable third-party party to help generate such profits.”
For the full comment letter and memo, please see here. In response to the registrant’s claims, the Staff decided not to issue any further comments on whether ZEN was a security or not and allowed the registration to go effective. The Staff did, however, make clear that their decision not to issue additional comments “should not be interpreted to mean” that they either agree or disagree with the analysis provided in the memorandum.
For those particularly interested in this topic, we thought you might find of interest this recently published paper titled “The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are Not Securities,” which argues why fungible crypto assets are not securities. We do not take a position on the merits of the article, but interesting nonetheless.
