On Wednesday (April 3), the U.S. Securities and Exchange Commission (SEC) issued its first crypto-related "no action" letter. In this article, we discuss the implications of this letter for issuers of crypto tokens.
Here is how the SEC defines a no-action letter:
"An individual or entity who is not certain whether a particular product, service, or action would constitute a violation of the federal securities law may request a "no-action" letter from the SEC staff. Most no-action letters describe the request, analyze the particular facts and circumstances involved, discuss applicable laws and rules, and, if the staff grants the request for no action, conclude that the SEC staff would not recommend that the Commission take enforcement action against the requester based on the facts and representations described in the individual's or entity's request."
The no-action letter the SEC published on April 3 was written by Jonathan A. Ingram—who works as Chief Legal Advisor at FinHub, which is within the Division of Corporation Finance— in response to an "incoming letter" (dated April 2) written by James Prescott Curry, counsel for Turnkey Jet, Inc. ("TKJ"), a private jet charter company based in West Palm Beach, Florida.
Facts and Circumstances of the TKJ Proposal
TKJ has 2-3 private jets. It has been in business since 2012. What TKJ proposes is launching a token membership program and developing a token platform to "facilitate Token sales for air charter services via a private blockchain network."
The idea is that each user will use the platform via an app that includes a wallet. TKJ envisions that there will be three types of users:
- consumers (individuals or businesses who buy tokens to get access to air chart services);
- carriers (companies that provide charter flights using their own fleet of private jets); and
- brokers (companies that broker charter flights between consumers and carriers).
All these three typeso of users are considered members of this program. All members will be required to pay membership subscription fees to take part in the program and buy tokens.
TKK will sell these tokens at a fixed price of one U.S. dollar per token " throughout the life" of the program. A typical transaction involves a consumer redeeming their tokens for air charter services (in a similar way that one would use "air miles" issued by an airline to book a flight).
The tokens will represent "a TKJ obligation to supply air charter services" to the consumer (token holder) "at a 1 USD:1 USD value, to allow for the variable costs of charter flights, jet fuel, catering, and other incidental costs related to each charter." Once a token enters circulation, consumers may sell their tokens to any other user of the membership program. TKJ will "implement technical restrictions" that will allow transfer of tokens to TKJ wallets only and not to any external wallets.
TKJ will fund development of its platform, network, app, and token "through its own capital resources" and not use any funds received through the sale of its tokens. By the time the tokens are sold, the TKJ platform, network, app, and token will be "fully developed and operational."
The tokens will be nonrefundable, i.e. consumers will only be able to redeem them for air charter services and not for USD. If TKJ offers to buy back tokens, "it will only do so at a discount to the face value."
Here are some of the facts that TKJ's membership agreement will require consumers to acknowledge:
- "The Consumer is not acquiring the membership or Tokens as an investment and has no expectation of economic benefit or profit as a TKJ Program Member or TKJ Token holder;"
- "The Consumer is solely acquiring the TKJ Program membership and Tokens for the right to obtain prepaid on-demand air charter services;"
- "The Consumer is acquiring the TKJ Program membership and Tokens for the Consumer’s own use and not with a view to sell or otherwise distribute the Tokens to anyone else in a secondary market;"
- "The Consumer will not have any equity or other ownership interest in TKJ or any affiliated entities; will not have any rights to dividends, distribution rights, or interest from TKJ or any affiliated entities at any time as a result of being a TKJ Program Member and TKJ Token holder; and will not have any voting rights regarding any matters relating to TKJ or any affiliated entities;"
Based on the above facts, TKJ's counsel believes that the TKJ token is not a "security" within "the meaning of Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Exchange Act," and therefore not subject to registration requirement of the Securities Act. In particular, he notes that there is no "investment contract" since there is "no reasonable expectation of profit derived from the efforts of others."
Implications for Crypto Companies Wishing To Offer Token Sales
It should not come as a surprise that the SEC agreed with TKJ's counsel that a extremely restricted utility token that cannot really be sold for a profit (since it is always possible to buy the tokens from TKJ for one USD each) fails the Howey test since the proposed token "fail to satisfy the third element regarding expectations of profit."
The message that this no-action letter seems to send companies thinking of offering crypto tokens for sale is that if your token is similarly restricted (i.e. fully functional at the time of the sale, purely used as payment for a service, no way to sell for a profit, no transfers outside the platform), you don't use the sale proceeds to develop the platform, and you approach the SEC before going ahead with your token sale, you have a good chance of receiving a similar no-action letter from the SEC and therefore you won't have to worry about being taken to court.
Here are some reactions from Crypto Twitter:
21/ The no-action letter itself isn't too interesting. There's little doubt that TKJ tokens aren't securities. We didn't need a letter for that.— Jake Chervinsky (@jchervinsky) April 4, 2019
But that's not what it was for. It was another message from the SEC: "if you come talk to us, we'll go easy." If you don't? 🤷♂️
This is a pretty fair take. The companion no action letter allows to you use a token on a private permissioned chain to pre-sell carnival tickets if the carnival already exists (& other factors). Not excactly big whoop shrug but close. The days of the 40x crapcoin on polo = ded. https://t.co/nn35d1sZST— Palley (@stephendpalley) April 3, 2019
The way I read the SEC's no action letter, it says "we won't take any action as long as you can't take any action with your token either" #cryptocurrency— Ajit Tripathi (@chainyoda) April 3, 2019
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