AN ANALYSIS OF THE LEGAL STATUS OF CRYPTOCURRENCY II: THE SEC STATEMENT ON DIGITAL ASSETS by -Odigbo Ugochukwu Sandra

The Securities and Exchange Commission(SEC) released a statement (“The Statement”) for the purpose of catering to the regulation of cryptocurrency in Nigeria. The statement announced that all cryptoassets are now considered securities thereby putting it under the regulatory authority of the SEC and the Investment and Securities Act (ISA) 2007. The statement made further provisions as to the registration, ownership and regulation of cryptoassets.

In an article previously published at www.pathsolicitors.com (“AN ANALYSIS OF THE LEGAL STATUS OF CRYPTO-CURRENCY IN THE NIGERIAN FINANCIAL SYSTEM”)^[1], we analyzed the existent legal regime on cryptocurrency in Nigeria and stressed the need for standard regulations to be put in place as the cryptocurrency world is a steady-rising area in line with internet related innovations constantly developing. Thus, this article provides insight into the meaning of securities, the import of the provisions of the statement, the legal effect of it.

The SEC Statement^[2]

On the 11^th of September, 2020, the management of the SEC signed a statement which was subsequently released on the 14^th to the effect that the SEC in the exercise of its powers intended to regulate the ownership, purchase, transfer and all matter incidental to cryptocurrency. The Statement provides that all cryptocurrency is considered a security and thus, falls under the purview of the SEC’s jurisdiction. This postulation is however declared to be subject to proof otherwise by the issuer or sponsor of said assets.

The purport of this provision is that all Cryptoassets are securities to be regulated by the SEC unless proved otherwise by the owner or handler. Thus, the burden is upon the person claiming that their crypto asset is not a security and does not fall under the SEC’s jurisdiction. The statement refers to a “two-pronged” approach for determining and registering the nature of cryptoassets. First, an initial assessment filing must be done to discharge the burden of proof. This is the interested party’s opportunity to present an argument about whether or not their crypto asset is a security or not. After this is done, the Commission will determine whether or not the asset qualifies as a security or not after which it will communicate its decision to the interested party either excluding the asset or declaring that the asset is indeed a security and must be registered.

Where the Commission determines that the asset is a security, the interested party must then file for registration. This step will also directly apply where the interested party does not dispute the status of the asset and desires to go directly to registration.

Existing crypto-owners have a period of three (3) months within which to begin the process above, as the case may be.

What will be regulated?

The Statement provides that the following shall be regulated by the SEC:

• Virtual crypto assets,
• Digital Assets Token Offering (DATOs),
• Initial Coin Offerings (ICOs),
• Security Token ICOs and
• other Blockchain-based offers of digital assets within Nigeria

Who will be regulated?

The Statement also provides that the following people shall be regulated:

• Any person, (individual or corporate) whose activities involve any aspect of Blockchain-related and virtual digital asset services, must be registered by the Commission and as such, will be subject to the regulatory guidelines. Such services include, but are not limited to, reception, transmission and execution of orders on behalf of other persons, dealers on own account, portfolio management, investment advice, custodian or nominee services.
• Issuers or sponsors (start-ups or existing corporations) of virtual digital assets shall be guided by the Commission’s regulation. The Commission may require Foreign or non-residential issuers or sponsors to establish a branch office within Nigeria. However foreign issuers or sponsors will be recognized by the Commission where a reciprocal agreement exists between Nigeria and the country of the foreign issuer or sponsor.
• A recognition status will also be accorded, where the country of the foreign issuer or sponsor is a member of the International Organization of Securities Commissions (IOSCO).

The Statement also goes further to provide how each virtual digital asset shall be treated.

• Cryptoassets i.e. non-fiat virtual currency shall be treated as commodities if traded on a Recognized Investment Exchange and/or issued as an investment, and is subject to Part E of SEC Rules and Regulations and any other relevant sections and subsequent Rules which will be enacted in future
• Utility Tokens or “Non-Security Tokens” (e.g., virtual tokens.) shall be treated as commodities. However, spot trading and transactions in Utility Tokens do not fall under SEC purview unless conducted on a Recognized Investment Exchange and therefore subject to Part E of SEC Rules and Regulations and any other relevant sections and subsequent Rules which will be enacted in future.
• Security Tokens” (e.g., virtual tokens that have the features and characteristics of a security) shall be Deemed to be Securities pursuant to Section 315 of ISA, “definition of Securities’’. 
• Derivatives and Collective Investment Funds of Crypto Assets, Security Tokens and Utility Tokens shall be Regulated as Specified Investments under the ISA & SEC Rules and Regulations. Market intermediaries and market operators dealing in such Derivatives and Collective Investment Funds will need to be registered/ approved by SEC.

Commodity, Currency or Security

In Article 1, we analyzed extensively the issues with classifying cryptocurrency as either a commodity or a currency and the problems arising from the confusion with classification as to the regulation of same. This poser has been expanded to include consideration of cryptocurrency as a security. First, we must determine what a security is.

A security is a tradable financial asset that has monetary value. It represents an ownership position in a publicly-traded corporation (via owning shares), a creditor relationship with a government body or a corporation (via owning bonds), or rights to ownership as represented by an option.^[3]

In determining whether cryptocurrency is a security, different rules apply to different kinds. Bitcoin cannot be classified as a security because Bitcoin came into existence as mining began as an incentive in validating a distributed platform, with no initial token offering, no pre-mined coins, and no kind of common enterprise. Bitcoin has never sought public funds to develop its technology and it does not pass the Howey Test^[4]. The position is less clear when it comes to other cryptocurrencies such as Ethereum (ETH) and Ripple (XRP). “Cryptocurrencies are replacements for sovereign currencies…[they] replace the yen, the dollar, the euro with bitcoin. That type of currency is not a security…… A token, a digital asset where I give you my money…[in exchange for] providing a return…that is a security and we regulate that. We regulate the offering and trading of that security,” ”^[5]

Currently, the answer to the question “is cryptocurrency a security?” seems to be “it depends” or “sometimes”. In determining whether cryptocurrencies are securities, the United Stated Supreme Court has developed a test called the Howey’s test. In SEC Vs W.J. Howey Co.^[6], it was stated that a transaction is an investment contract if:

1. It is an investment of money
2. There is an expectation of profits from the investment
3. The investment of money is in a common enterprise

Any profit comes from the efforts of a promoter or third party^[7]However, their fundamental goal of being autonomous and distributed networks that are designed to be decentralised is at odds with the regulated nature of securities.

Legal effect of the SEC statement

The SEC is the body mandated to make regulations regarding securities, investments and innovation in Nigeria. This power is granted by the investment and Securities Act, 2007. The SEC has made several regulations including the Rules and Regulations of Derivative Trading, Rules of Central Counter Party, etc.

The above mentioned Regulations and all other regulations have the force of law drawn from Section of the Investment and Securities Act, 2007. However, a mere statement does not. The statement of the SEC is similar to several statements previously made by both the SEC and the CBN on the subject of cryptocurrency and other subjects. These statements merely convey the future intentions and concerns of the SEC and the CBN and were copiously referred to in Article 1.

Subsequently, a regulation may be made encompassing the content of the statement which Regulation shall then have force of law. Thus, the statement as it currently stands is merely that: a statement. It does not constitute a binding legislation and has no force of law. Thus, it does not currently regulate the cryptocurrency world at all.

Legal Issues with the Statement

• Jurisdiction Issues

The statement expressed the intention of the SEC to create regulations for crypto-tokens/crypto-coin investments based on the regulatory powers conferred by Section 13, ISA. Thus, to do this, the SEC had classified all virtual currencies as securities until proven otherwise. This means that the Commission has placed itself in a position to regulate all cryptocurrency in Nigeria. However, it may be argued that this is a gross expansion of the Commission’s powers as the classification of all cryptocurrency as security is unfounded. Certain cryptoassets do not pass the Howey’s test.

Although sometimes, cryptocurrency falls under this classification, it is often used as mere currency to transact businesses and transfer funds in which case it would be difficult to classify as a security. There is also an emergence of online investment schemes and businesses issuing cryptocurrency as forms of participation and “party favours”. These other crypto trade businesses can neither be classified as issuers or sponsors of cryptoassets as they mostly deal with cryptocurrency as a currency and means of exchange.

Furthermore, there is a lack of centralization with cryptocurrency unlike other regular securities. There is no central authority and this may prove problematic for the tracing of crypto ownership. Also, as discussed in Article 1 is the issue of anonymity. Ownership of cryptocurrency is usually registered in codes and numbers and not in a bank account like regular currency or in the Nigeria Stock Exchange as regular security. How does the Commission intend to track ownership and thereby regulate it except by imploring the public to submit to their jurisdiction?

• Ambiguity

The failure of the Commission to clearly delineate the factors determining the qualification of crypto assets as security has left the interpretations wide open. This confusion is further widened by the provision that crypto-owners have to prove that their assets do not qualify to be exempt from the registration process. The lack of specificity of the statement  creates a lacuna which can be exploited.

Also, the attempt to regulate all transactions relating to all the existing forms of cryptocurrency is quite wide. Some usage of cryptocurrency can clearly be classified as commodity while some are currency; in both situations, bodies different from the SEC are empowered to handle it. However, the attempt by the SEC to regulate it all may be confusing. The Commission needs to expressly stipulate the powers it shall have over cryptocurrency and the businesses and transactions it shall cover relating to same.

• Bindingness

As stated earlier, the document released by the SEC is merely a statement and has no force of law. It is similar to previous statements made by the SEC, CBN and other bodies and cannot be enforced against anybody as of yet. Thus, the declarations and provisions contained in the Statement do not have any legal backing and shall have the effect of an announcement merely made.

Conclusion

The innovation by the SEC is a timely one and it caters to an unregulated sector which sorely needed regulation. However, in making the statement, the SEC has made some overgeneralizations which have been highlighted in this article. Fortunately, the Statement is not a binding one and has no force of law. Thus, the SEC can correct the mistakes made when drafting the final regulation.

The SEC can specify a definition of the securities which cryptocurrencies, on fitting with the definition, become subject to the jurisdiction of the SEC. This way, the SEC does not seek to regulate all cryptocurrencies; rather, it provides criteria which align with the meaning of securities and puts that cryptoasset under its purview. This will also resolve the jurisdiction issues by delineating the application of the Regulation to cryptoassets that are securities.

In the meantime, we await the codification of the statement into a regulation. Until that is done, the legal regime as explained under Article 1 subsists and all cryptocurrency transactions are governed by pre-existing laws like the Cybercrime Act.

[1] Available at https://pathsolicitors.com/an-analysis-of-the-legal-status-of-crypto-currency-in-the-nigerian-financial-system/

[2] The SEC Statement on Digital Assets and their Classification and Treatment; available at www.sec.gov.ng/statement-on-digital-assets-and-their-classification-and-their-classification-and-treatment-/ accessed on 5^th October, 2020

[3] Definition available at <https://finance.yahoo.com/news/cryptocurrency-security-140020233.html#:~:text=The%20crypto%20security%20debate&text=SEC%20chairman%20Jay%20Clayton%20has,currency%20is%20not%20a%20security.%E2%80%9D> accessed on 5^th October, 2020.

[4] SEC Vs W.J. Howey Co., 328 U.S. 293 (1946)

[5] Chairman Jay Clayton; SEC chairman, United Stated of America on CNBC: Nature of cryptocurrency”

[6] Supra

[7] “Is Cryptocurrency a security” available at https://finance.yahoo.com/news/cryptocurrency-security-140020233.html#:~:text=The%20crypto%20security%20debate&text=SEC%20chairman%20Jay%20Clayton%20has,currency%20is%20not%20a%20security.%E2%80%9D accessed on 5^th October, 2020.