SEC’s Corp Fin Says Most Stablecoins Are Not Exchanged in Securities Transactions

On April 4, the SEC released a Statement on Stablecoins. In the statement, the Division of Corporation Finance provides its view that offers and sales of a certain subset of crypto assets commonly known as “stablecoins” generally are not securities transactions under federal law. Corp Fin notes that the statement is “part of an effort to provide greater clarity on the application of the federal securities laws to crypto assets.”

The statement only addresses stablecoins “that are designed to maintain a stable value relative to the United States Dollar” and can be redeemed for United States Dollars on a one-for-one basis using a fully collateralized reserve. An “unlimited mint-redeem” structure allows unlimited units of the stablecoin to be minted and redeemed as long as corresponding assets are held in reserve. The mint-redeem process may be handled by the issuer or designated intermediaries. Stablecoins covered by the statement must be backed by a reserve of assets “that are considered low-risk and readily liquid” (such as U.S. Treasuries or money market funds) with a USD value that meets or exceeds the redemption value of the stablecoins in circulation. The statement does not cover stablecoins backed by other crypto assets, physical commodities, non-USD fiat currencies, algorithmic methods, nor redeemable into non-USD assets.

The stablecoin reserve must only be used for redemptions, never used for operational purposes, never lent nor pledged, and must be held in a manner so as to make reserve assets not subject to third-party claims. Corp Fin recognizes that reserve assets may be interest generating, but that stablecoin holders may not have any rights to such profits. Corp Fin noted that issuers “[i]n some cases” publish a “proof of reserves,” but did not comment on whether such transparency would be relevant to the application of securities laws.

Application of Federal Securities Laws to Stablecoins

Federal securities laws define a “security” by providing a long list of financial instruments. Crypto assets are not on this list. Corp Fin therefore considered whether stablecoins would satisfy the “family resemblance” test to be a “note” under Reves v. Ernst & Young, 494 U.S. 56 (1990) or whether transactions involving stablecoins would qualify as “investment contracts” under SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

Reves Analysis

In Reves, the Supreme Court held that a “note” is presumptively a security, but that this presumption could be rebutted if the note resembles one of the types of notes commonly issued in commercial transactions. This “family resemblance” test considers four factors:

1. Motivations of seller and buyer
2. Plan of distribution
3. Reasonable expectations of the investing public
4. Risk-reducing factors

The Reves test balances these four factors, and no single factor is dispositive. Weighing the four factors, Corp Fin found that none supported finding that stablecoins are exchanged as securities:

1. Motivation of Seller and Buyer: Under Reves, if an asset is exchanged “to advance some other commercial or consumer purpose,” it is unlikely to be a security.¹ In contrast, if it is sold for fundraising purposes for a business enterprise, with purchasers “interested primarily in the profit the note is expected to generate,” such an asset is likely a security.² Corp Fin reasoned that stablecoin purchasers expect price stability and intend to use the asset in money transmission. Further, because the stablecoin reserve assets may only be used to pay redemptions, issuers are not promising returns based on deploying reserve assets. Therefore, this factor weighs against finding that stablecoins resemble securities transactions.
2. Plan of Distribution: This factor considers whether there is “common trading for speculation or investment” and whether the assets are “offered and sold to a broad segment of the public.” ³ Corp Fin reasoned that while stablecoins are commonly traded and sold to a broad segment of the public, their design and intent does not encourage trading for investment or speculation. While some arbitrage opportunities exist to the extent a stablecoin trades on secondary markets at a price other than its redemption value, these “minimal” arbitrage trades do not change the character of the asset. Therefore, Corp Fin found that this factor also weighs against finding that stablecoins are securities transactions under Reves.
3. Reasonable Expectations of the Investing Public: This factor considers “on the basis of . . . public expectations” whether a note is characterized “as an ‘investment.’”⁴ Corp Fin reasoned that stablecoins, as defined in the guidance, are designed and marketed as stable and accessible means of transfer value. Therefore, there is little to no basis for a reasonable buyer of stablecoins to expect investment-like characteristics, and this factor too weighs against finding that stablecoins resemble securities transactions.
4. Risk-Reducing Features: The fourth factor considers the presence of collateralization, insurance, and the applicability of other regulatory regimes that “significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary.”⁵ In Corp Fin’s view, the fully funded reserve feature of stablecoins serves as a risk-reducing feature of stablecoins, making this factor also guide against stablecoins being considered securities transactions under Reves.

Howey Analysis

Under Howey, the following elements constitute an “investment contract”:

1. The investment of money
2. In an enterprise premised on the reasonable expectation of profits
3. Derived from the entrepreneurial or managerial efforts of others

The Howey test requires that each factor be satisfied for an asset to be a security. Reviewing these factors, Corp Fin found that stablecoins covered by this guidance do not meet the second factor, a reasonable expectation of profits. According to Corp Fin, these instruments “are not marketed as investments or with any emphasis on the potential for profit,” and buyers purchase stablecoins for use, not because of the prospects of a possible return on an investment. The court in Securities and Exchange Commission v. Binance Holdings Limited, 1:23-cv-01599 (D.D.C.) previously expressed a similar view, ruling that Binance’s BUSD stablecoin was not an investment contract on the same rationale. Because the second factor is not met, stablecoins are not “investment contract” securities under Howey, according to the guidance.

Marketing Stablecoins

Corp Fin also provided guidance on marketing statements about stablecoins that, in their view, are indicia that a stablecoin is not offered or sold as a security. These include statements that the stablecoin:

• Is designed to have a stable value relative to USD
• Does not entitle a holder to receive any interest, profit, or other returns
• Does not reflect any investment or other ownership interest in the issuer or any other party
• Does not afford governance rights
• Does not expose a holder to returns or losses based on the issuer or any third party’s financial performance

Limitations of Corp Fin’s Advice

As Corp Fin disclaims, its statement “is not a rule, regulation, guidance, or statement” of the SEC; the SEC has not approved or disapproved the statement; and “like all staff statements,” it “has no legal force or effect.” However, as with other recent SEC guidance, the statement suggests a shift in focus away from pursuing enforcement actions against stablecoin issuers for failure to register securities. Corp Fin additionally notes that stablecoin issuers “may be subject to regulation under state law, and such regulation may prescribe the permissible assets that may be held in a [r]eserve.”

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Footnotes

¹ Reves at 66.

² Id.

³ Id. at 67.

⁴ Id. at 66, 68-69.

⁵ Id. at 67.