A Most Famous Crypto Case
One of the key complaints about crypto is that the line between which crypto coins are securities and which are not is unclear. Many, for example, look at a coin and are puzzled – when is it a security and when is it not a security. This “now it is, now it is not” approach can cause confusion.
Yet there is nothing unclear about the rules that apply to making the determination. Those lines were drawn clear and sharp by the Supreme Court decades ago in SEC v. W. H. Howey, 328 U.S. 293 (1946). There the Court focused not on an object such as a coin or a bit of paper like a stock certificate but the economic reality of the transaction. Viewed through this lens the issue is straight forward: Are the funds of the investor pooled with those of other investors with the hope and expectation that the pool will increase in value not because of something the investor did but through the efforts of others. If, and when, this happens the investment is a security – not the coin itself which is actually a commodity.
The recent case involving celebrity Kim Kardashian is a good illustration. In the Matter of Kimberly Kardashian, Adm. Proc. File No. 3-21197 (October 3, 2022). Ms. Kardashian was retained to promote a crypto token called EMAX. She was paid $225,000 to promote the token. The tokens were promoted beginning in May 2021 in social media and marketing material. Ms. Kardashian also posted about the coins on her Instagram account which included an introductory video.
In the advertising materials the company that issued the coins assured purchasers that the coins would be traded in a secondary market. The marketing materials also discussed the management of the company in addition to promoting the coins.
Prior to the EMAX promotion the Commission had issued the DAO Report of Investigation on July 25, 2017, according to the Order. The report focused on the economic reality test of Howey. It also discussed what has now become known as the “ecosystem” surrounding the crypto coins – the efforts of others part of the Howey test that creates the hoped for profits with the pooled investor money.
While it is clear that Ms. Kardashian promoted the coin as promised, what she did not do is disclose that she was a paid promoter of the coins; nor was the amount of money she was paid disclosed. This violated Section 17(b) of the Securities Act.
Ms. Kardashian resolved the proceedings by cooperating with the Commission and agreeing not to receive any form of compensation for three years for promoting a crypto asset security and to continue to cooperate with the agency. She also consented to the entry of a cease-and-desist order based on the Section cited in the Order. In addition, Ms. Kardashian will pay disgorgement of $250,000, prejudgment interest of $10,415.35 and a $1 million penalty.