The SEC’s Shift in Perspective
On February 27, 2023, the staff of the SEC’s Division of Corporate Finance released important guidance regarding memecoins—digital assets that draw inspiration from internet memes, characters, current events, or trending topics, typically aimed at cultivating an enthusiastic online community. This guidance indicates that memecoins are generally not classified as securities, marking a notable shift in the SEC’s regulatory approach.
This change aligns with the SEC’s evolving stance as it moves away from the expansive regulatory efforts initiated during the tenure of former Chair Gary Gensler. The implications of this guidance extend beyond just memecoins, potentially reshaping the broader digital asset landscape.
Understanding the Howey Test
The SEC’s regulatory framework under the Biden Administration has relied heavily on the Supreme Court’s “Howey test,” which determines whether a transaction qualifies as an “investment contract.” According to the Howey test, an investment must involve a monetary contribution to a common enterprise, with an expectation of profits derived from the efforts of others.
In various enforcement actions against digital asset exchanges, defendants have argued that secondary-market resales of digital assets do not meet the criteria for the Howey test. They contend that investors’ funds are not pooled together by developers for a common purpose, which would be necessary for it to be deemed an investment contract. In its case against Kraken, for instance, the SEC claimed that “pooling of resale proceeds” by developers is not a requirement of the Howey test.
New Insights on Memecoins
The SEC’s recent guidance directly contradicts previous assertions. It clarifies that individuals purchasing memecoins do not engage in a common enterprise, as their funds are not collectively managed by promoters or third parties for the development of the coin or related ventures. Additionally, it emphasizes that memecoin buyers do not anticipate profits based on the efforts of others; instead, the value of these assets arises from speculative trading and market sentiment, similar to collectibles.
Implications for the Digital Asset Market
While the guidance primarily addresses the sale and promotion of memecoins—currently the subject of private class actions by individual plaintiffs—it has far-reaching consequences for all secondary-market transactions involving digital assets, including those on exchanges. The SEC now appears to acknowledge that funds in these transactions are not pooled for development purposes, which aligns with defendants’ arguments in previous enforcement cases. This doctrinal shift could explain the SEC’s recent decisions to dismiss several cases involving secondary-market transactions and to pause proceedings in others.
A Cautious Outlook
It is important to note that the SEC’s guidance represents the views of its staff and does not carry legal weight. The agency has also attempted to limit the guidance to the “offer and sale of memecoins” under specific conditions outlined in the release. This language could provide the SEC with a way to distance itself from the guidance in the future. However, principles of constitutional due process and fair notice may restrict the agency’s ability to impose retroactive liability should it choose to reverse its position later on.
While the guidance is not legally binding on courts, the SEC’s revised stance on pooling funds complicates the ability of private plaintiffs to argue that most digital assets are classified as securities.
A Positive Step for Crypto Regulation
The SEC’s guidance on memecoins aligns with the agency’s recent moves to retreat from the regulation-by-enforcement strategy that characterized the Gensler administration. This new clarity offers a more coherent framework in a previously convoluted area of law, marking a significant and positive step forward for cryptocurrency regulation and policy in the United States.
