LEGAL OPINION
SOGE TECH LLC – INITIAL COIN OFFER
Introduction, Background and nature of blockchain tokens
ICO represents a new way of crowd funding that allows promoters to accumulate a certain amount of funds for developing and enhancing blockchain start-up projects. In such a manner, in consideration of funds received from purchasers, the latter obtains tokens that may be exploited in numerous ways depending on peculiarities of ICO projects.
There are many types of blockchain tokens, each with their own characteristics. For example, one kind of blockchain tokens may be used in a blockchain protocol to fuel functioning of an application designed on it. Another kind of tokens may be utilized as a virtual (digital) currency that is served as a certain medium of exchange both within a certain blockchain platform and beyond that.
An inherent feature of any token is to be tradable on a “secondary market” of tokens on a cryptocurrency exchange market. That is to say, a token is free for sale and after being issued is subject to market speculations according to the rules of demand and supply.
However, there is a number of complicated legal issues concerning tokens since some of them may fall into a definition of a security instrument and therefore be subject to the US federal or state securities laws. As a consequence, it means that the sale of such tokens may be illegal for US residents.
In many jurisdictions, there may also be issues under anti-money laundering laws and general consumer protection laws, as well as specific laws depending on what a token actually does.
Based on our analysis of the current case law, regulations issued by the competent government institutions in different parts of the world, including such agencies as SEC (Security and Exchange Commission) or CFTC (Commodity Futures Trading Commissions), MAS (Monetary Authority of Singapore), ECB (European Central Bank) and various facts and materials derived from a plethora of ICO’s conducted in different parts of the world, we conclude that appropriately designed token may not entail risks of being recognized as an investment instrument.
Nevertheless, it has to be clearly understood that we cannot provide a thorough review amid the compliance with the regulatory regime of each jurisdiction. Hence, in this legal opinion we will focus on the United States security law.
This opinion is devoted to the examination of a token issued by SOGE on its risk of being considered an investment instrument (hereinafter – “SOGE Token” or “Token”).
In section I, we introduce you to the general concept of an ICO and blockchain token. Section II describes a security law framework for blockchain tokens in light of SEC Report. In the third section, we analyze whether a SOGE Token meets the Howey Test and then in Section III we sum up whether SOGE Tokens fall into a definition of security instruments or not.
Security law framework for blockchain tokens in light of SEC Report.
In re SEC v C.M. Joiner Leasing Corp., 320 U.S., 344, 351 (1943) it was established that
“the reach of the securities Act does not stop with the obvious and commonplace. Novel, uncommon, or regular devices, whatever they appear to be, are also reached if it be proved as a matter of fact that they were widely offered or death in under terms or courses of dealing which established their character in commerce as “investment contract”’ or any interest or instrument commonly known as security”
The same was held in Reves v. Ernest and Young 494 u.s. 56,61 (1990)
“Congress purpose in enacting the securities laws was to regulate investments, in whatever form they are made and whatever name they are called”
The U.S. Securities and Exchange Commission adheres to this position and declares that any new forms of investments via smart contracts or blockchain technology fall under the purview of US federal securities laws and on July 25, 2017 issued a section 21 (a) investigate report, Release No. 81207 (“the Report”) on investigation of DAO case.
Any others, the Report distinguishes ICOs tokens represent securities as described above. Hence, in this analysis we shall investigate and provide our legal opinion as to whether SOGE ICO is a type of crowd funding that does or does not trigger prospectus requirements and any of security laws provisions of the United States.
Security Law Analysis for SOGE Tokens
- For purposes of this analysis we have researched the White Paper (WP) of the unit ICO project and adopted the following terms.
As it is stated in WP, the original intent of SOGE Tokens was “provide humbleness and authenticity at the lowest levels of the cryptocurrency meme space.”
It also can be inferred out of WP that purchase of an SOGE Token “will allow people to won or mint NFTs crafted from high-powered telescopic images captured from partnered observatories which have sold the rights of their intellectual property to SOGE tech.”
SOGE Platform evangelizes the use and enjoyment of interactive astronomical study experiences from the comfort of your mobile device:
“As envisioned, this would allow the end user to act as their own observatory or explore stars with the help of a trained astronomer while maintainting the capacity to mint NFTs as souveniers of the experience whilst retainig copy right to their own works.”
- Howey Test and Its adoption by the Federal Courts
In accordance with Section 2(a)(1) of the Securities Act, security means:
“any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement… investment contract … or, in general any interest or instrument commonly known as a ‘security’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of.”
Exchange and Securities Acts tend to control the emission of investment instruments and to testify particular interests attached. However, the Security Law evangelizes the priority substance over the form. Therefore, if the Security and Exchange Commission reveals any type of cooperation promising any future profits merely out of signing a particular contract, it may investigate the case and declare this contract a security instrument. Under such circumstances, promoters of such an instrument shall disclose particular information and submit it to SEC.
In SEC v. Howey, 328 U.S. 293 (1946), the promoter offered to purchase certain services (cultivation of land) for the fixed price and cost of services. It is important to note that the promoter further was delegated to distribute the net profits derived from the sale of the flourishing land among the holders of tracts of land at the harvesting period. There were only 42 investors interested in purchasing land.
Analyzing the fact pattern, the Court expands over “investment contract’ within the definition of a security, noting that it has been used to classify those instruments that are of a “more variable character” that may be considered a form of “a contract, transaction, or scheme whereby an investor lays out money in a way intended to secure income or profit from its employment.” 11 Howey, 328 U.S. at 298; Golden v. Garafolo, 678 F.2d 1139, 1144 (2d. Cir. 1982).
More specifically, the court concludes that the contract between the promoter and investor constitutes an investment contract. The court explains the definition of a security transaction as follows: “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
Moreover, the court said that this definition is “crystallized” in the state courts cases that were far beyond adoption of the federal act. The Supreme Court continues that the term “had been broadly construed by state courts so as to afford the investing public a full measure of protection. Form was disregarded for substance and emphasis was placed on economic reality.”
The Court stated that its definition of investment contracts “embodies a flexible rather than a Static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”
Eventually, the court articulates the following four-part tests to face an investment contract: (i) an investment of money;(ii) in a common enterprise;(iii) with an expectation of profits; (iv) solely from the efforts of others (e.g., a promoter or third party).
Upon the first prong “investment of money”, there is no basis for disagreement. The only issue that may arise here is whether cryptocurrency may constitute a viable consideration interesting lieu of the obtained interests attached to the token. This issue is addressed by the Supreme Court itself holding that the first prong requires only “tangible and definable consideration in return for an interest that had substantially the characteristics of a security.”
However, the Supreme Court fails to specify the definition of a common enterprise. Federal circuits developed two different concepts to analyze the underlying contractual relationships of the parties. The first doctrine is a “horizontal commonality” and the second is a “vertical commonality”. A horizontal commonality is found when a) investors’ contributions are pooled and b) the fortune of each investor rests on the success of the overall enterprise.
In contrast, a vertical commonality presupposes that a common enterprise may be found where the investors’ fortune is dependent on the expertise of the promoter or third parties. In case of a narrow vertical commonality, investors’ profits shall be tied to the profits of managers. In a broad vertical commonality, investors success depends on the efficacy of the manager or third parties. As it was mentioned above, the circuits now disagree over the term “a common enterprise.”
The third prong is an “expectation of profit derived from the entrepreneurial or managerial efforts of others.” Analyzing this prong, courts consider whether potential investors 1) expect to receive profits from their own efforts (use of rights or services obtained from promoters) or 2) from the efforts (managerial expertise) of the ICO founders. Even though in re Howey, the Court used the phrase “solely” from the efforts of others, the lower courts relaxed this prong, adopting concepts “undeniably significant” or “predominantly”.
The federal courts now have divided in its application of “so/e/y” standard introduced by the Supreme Court. Some courts are investigating whether there is “de minimis” efforts of investors and whether their efforts are an insubstantial factor for the investor to participate in the contract.
Other courts, have a look whether efforts of offerors of the contract are predominant and more significant in comparison with those of investors in light of the future expectation of profits or that efforts of those other than the investors are “the undeniably significant ones.”
Finally, some courts hold that the third prong is satisfied when the expectations of profits derive from the managerial and entrepreneurial efforts of the offerors, “in unspecified measure and unspecified comparative weight as to the relative significance with investors’ efforts and offerors’ or third parties’ efforts.”
C. Analysis Under the Howey Test
We provide our analysis of a non-security Blockchain Token below, based on each Howey factor.
(1) Investment of Money
The first prong is clear here since promoters of SOGE Tokens offer their tokens for sale in exchange for fiat or any cryptocurrency. Therefore, this factor leans towards a SOGE Token being security.
(2) Common Enterprise
Under a horizontal approach, a common enterprise is not likely to be found. While contributions of SOGE Token holders may be pooled together for the development of the Platform as it is described below, it cannot be proclaimed that profits of each SOGE Token holder rests on the profits of other holders.
SOGE Tokens must be purchased by persons who wish to access the SOGE Platform and the resulting functions of the Platform are customizable by the Token holders depending on their individual needs and preferences. Therefore, the Platform offers each individual Token Holder access to specific functions of the Platform. Each holder owns only the right to access and use the Platform, and does not have any right of ownership or disposal of the Platform or its assets. Therefore, this factor leans towards a SOGE Token being a utility.
Therefore, it cannot be concluded that fortune and profit of one token holder of the Platform correlates with the fortune or profit of another. And it cannot be concluded that under a horizontal approach, there is any evidence of a common enterprise.
We also do not believe that a common enterprise may be found applying a vertical commonality approach.
As with the horizontal commonality, in narrow and broad vertical approaches, SOGE Token holders’ fortune in some respect depends on the success of the whole company. For instance, an investor is likely to profit with the raise of a token’s price resulted out of the effective managerial actions of the managers of the Platform or founders of the SOGE ICO. According to the White Paper, it can be inferred that prospective Token purchasers are not granted with any right to share potential profits from activities of SOGE founders. Hence, no reasonable investor would be enticed to purchase the token merely expecting to receive future dividends out of its trading.
Therefore, we believe a SOGE Token does not satisfy this prong of the Howey Test.
(3) Expectation of Profits
On the one hand, SOGE Token holders may benefit from its use by selling them on a cryptocurrency exchange market. However, on the other hand, it cannot be ultimately declared that tokens may be purchased exclusively for speculation purposes.
As it was described above, the Platform suggests to its users a plethora of opportunities. SOGE Token holders’ smart use of the Platform’s facilities to observe and study the astronomical plane while maintaining the capacity to mint NFTs as souvenirs of the experience whilst retaining copyright to their own works.
According to the White Paper, SOGE Token holders have the voting right. However, unlike with the DAO, prospective purchasers are not granted with any right to share potential profits from activities of SOGE founders. Hence, no reasonable investor would be enticed to purchase the token merely expecting to receive future dividends out of its trading.
Therefore, we believe a SOGE Token does not satisfy this prong of the Howey Test.
(4) Solely from the Efforts of Others
As we discussed above, not all courts share an approach of the Supreme Court using the term “solely” defining the efforts of others. Some federal courts relaxed this approach exploiting “de minimis” efforts of others or the concept of “undeniably significant” or predominantly.
If we apply the concept “only” from the efforts of others, this prong is more likely not to be satisfied, since SOGE Token holders use the token as a license right to unlock the Platform. This right allows users of the Platform not only derive income out of the use of the Platform via a SOGE Token but also to participate in the development of the SOGE ecosystem voting “to decide what features should be implemented to the builders of the company.”
At the same time, it is also true that founders of the Platform also work on the software to make it more interesting functionally and as a result more attractive for the users. Since under such circumstance the market value of a token increases and so investors’ active assets arise, it is fair to declare that the expected profits derived from the efforts of others as well.
Therefore, if we apply a strict approach of the Supreme Court focusing on efforts of third parties this prong is more likely yet to be satisfied. However, if we apply a relaxed approach either of the Federal Courts this element of the Howey Test may be satisfied.
IV. Summary and Conclusion
As we may see, the Howey Test met only partly. The first prong (investment of money) is for SOGE Token to be considered a security. The factor of the common enterprise we consider not to be satisfied. The third factor is not satisfied either. The fourth factor depends on the relevant and specific approach used by the courts and may or mandelate the token to be a security instrument that is true regardless of the type of the reward promised to managers of the Platform, whether it is a fixed price or profit sharing.
Nevertheless, even if the SOGE enterprise may not demonstrate successful development of the company in the future and increase in a market value of a SOGE Token, its functionality will not be diminished, hence investors will continue enjoy tokens and receive advantages of the Platform.
Therefore, and considering the above mentioned, we suppose that this prong is more likely to push the scale toward a SOGE Token not being deemed a security.
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