November 07, 2017 127By James Sowers
First keep in mind the author is not a securities lawyer and is not giving legal advice or suggesting that all tokens are securities, I will leave that to those much wiser than myself.
Reves vs. Ernest &YoungSo let's start by explaining the reeves test. Under the “family resemblance” test, one must start with the presumption that a note is a security which is rebutted if the note bears a resemblance to one of the enumerated categories on a judicially developed list of exceptions. If the “note” does not bear a resemblance to an item on the list, the analysis continues to determine if a new category should be added to the list. The following is : (i) The motivation of seller and buyer – The first factor is described as the motivation that prompts “a reasonable seller and buyer to enter into” the transaction. If the seller’s motivation is to raise money for his/her business and the buyer’s motivation is to earn profits, then the note is likely a security. Even if the note is not necessarily characteristic of a security, if the investor reasonably expected that they were buying a security, and would be protected by the accompanying securities laws, the courts can determine that indeed a security has been sold. (ii) The plan of distribution of the instrument – The second factor determines whether the instrument is being distributed for investment or speculation. If the note instrument is being offered and sold to a broad segment or the general public for investment purposes, it is a security. (iii) The reasonable expectations of the investing public – An instrument will be deemed a security where the reasonable expectation of the investing public is that the securities laws (and accompanying anti-fraud provisions) apply to the investment. (iv) The presence of alternative regulatory regime – The fourth and final factor is a determination whether another regulatory scheme “significantly reduces the risk of the instrument, thereby rendering the application of the Securities Act unnecessary.” The FDIC and ERISA laws are two such examples. Both before and after Reves, the issue of whether bank notes or CD’s are a security has been often litigated. In Marine Bank vs. Weaver, 455 U.S. 551 (1982), the U.S. Supreme Court held that a federally insured bank CD is not a security. In that case the court relied heavily on the fact that the bank was federally regulated and the subject CD was federally insured. The Court stated that CDs could be securities subject to the Act in other contexts and that instruments “must be analyzed and evaluated on the basis of the content of the instruments in question, the purposes intended to be served and the factual setting as a whole.”
HypothesisIf the Reves test applies then a company could do a token offering as a security under Reg A+ or even file an S-1 for larger companies even already publicly traded ones. Under this scenario the company could birth a membership or redemption token with a stable value that could be exchanged for goods and services in the echo system. There is legal precedents that this type of thing is legal and and they were not considered a security. In 1972 S&H Greenstamps was brought before the Supreme Court for violating the unfairness doctrine. In FTC vs. Sperry & Hutchinson Trading Stamp Co.. companies could also birth protocol tokens to be initially purchased with the security token only by developers and strategies in order to build Dapps in the echo systems. As an eventual liquidity event companies could later spin out the token into an actual security token in the same way publicly traded companies spin out equity. I could even see a future where division are spun out into security tokens to the current security token holders. The second scenario I see is similar to the 1st except the company currently does not have any tokens and they simply create membership token for their members similar to the virtual currency in games that zynga has created. Companies could also create a protocol token were developers could be rewarded in the echo system for their accomplishments in a similar fashion. In these 2 scenarios an exit or liquidity event could occur in 2 ways. A public security token spinout or the company buying the tokens at a fixed price.
Disclaimer the author is not a lawyer and is not giving legal advice this article is for informational purposes only.