Even before the collapse of Sam Bankman-Fried’s FTX empire, the Securities and Exchange Commission (SEC) was paying increasing attention to the market for cryptocurrencies. Back in June, the Chair of the SEC, Gary Gensler, famously stated that crypto exchanges that are not cooperating with the SEC are “operating outside of the law.” The question of whether or not cryptocurrencies are securities was a central question in the class action fraud lawsuit against Kim Kardashian, Floyd Mayweather, and others, which was eventually dismissed. That suit wasn’t Kardashian’s only legal action pertaining to crypto, however; in October, the SEC charged her for failing to disclose the payment she received for touting EthereumMax’s tokens, which the SEC called “crypto asset securities” in a press release. Kardashian was fined $1.26 million, which she paid.
After the collapse of FTX, however, the question has come under renewed scrutiny. Another class action lawsuit has been filed by investor Edwin Garrison against a laundry list of celebrities: Tom Brady, Gisele Bundchen, Steph Curry, Shaq, Udonis Haslem, David Ortiz, Trevor Lawrence, Shohei Ohtani, Naomi Osaka, Larry David, and Kevin O’Leary. The complaint specifically alleges that FTX offered and sold unregistered securities and that the named celebrities violated the same anti-touting provisions of the federal securities laws of which Kardashian fell afoul.
So, as the above celebrities are no doubt wondering, are cryptocurrencies securities? It seems that, in the world of crypto, which has been called “the ‘Wild West’ of financial markets,” the answer is…it depends. The Securities and Exchange Act of 1934 defines securities, but the Supreme Court case SEC v. Howey provides the test to apply. The Howey Test, as it is known, states that an asset is an investment contract, and therefore a security, if: (1) Someone invests money, (2) in a common enterprise, (3) with the expectation that they will profit, (4) from the efforts of others. If a particular token satisfies the Howey Test, it is a security under U.S. law. The current Chair of the SEC believes that “most crypto tokens are investment contracts under the Howey Test.” The answer to whether FTX’s yield-bearing cryptocurrency accounts qualify is a question that the celebrities named in Garrison’s lawsuit will await with bated breath.