A recent court ruling is providing more clarity to the question of when digital assets are subject to securities laws and serves as notice to issuers and investors alike of increased enforcement efforts by the SEC in cryptocurrency cases.

U.S. District Judge Alvin Hellerstein’s Sept. 30, 2020 ruling granted summary judgment to the SEC in its case against Kik Interactive, Inc., ruling that Kik’s unregistered offering of digital tokens, or cryptocurrency, called “Kin” was an offer and sale of securities without a registration statement or applicable exemption in violation of Section 5 of the Securities Act of 1933 (see U.S. S.E.C. v. Kik Interactive, Inc., 19 Civ. 5244 (AKH), slip op. (S.D.N.Y. Sept. 30, 2020)).

Citing the four-pronged “Howey test,” the court ruled that the sale of Kin to the public constituted a security as:

  1. An investment contract
  2. In a common enterprise
  3. With the expectation of profit
  4. Based solely on the efforts of the promoter or a third party.

Kik had pre-sold Kin to accredited investors using a Simple Agreement for Future Tokens (“SAFT”), arguing that it was exempt from registration. The court disagreed, noting that the subsequent public sale of Kin was part of the same integrated offering, which therefore meant that the pre-sale did not qualify for exemption.

This SEC court victory follows a case earlier this year (SEC v. Telegram Group, Inc., 448 F. Supp. 3d 352 (S.D.N.Y. 2020)) in which it was ruled that Telegram’s initial sale and distribution of a digital token (called Grams) through SAFTs, and potential resale by early purchasers in the secondary market, were part of an illegal unregistered offering of securities.

Numerous such offerings of cryptocurrencies without registration have been made and could be impacted by these rulings as other U.S. courts consider the issue in pending or yet-to-be filed SEC enforcement actions.

Bottom line: Anyone contemplating issuing digital tokens should seek qualified legal counsel beforehand, to ensure you are adhering to applicable securities laws.