When do Secondary Token Sales Violate the Howey Test

The federal judge overseeing the U.S. Securities and Exchange Commission’s (SEC) lawsuit against Binance has ruled that most of the case can proceed, but has dismissed charges related to the sale of BUSD and the secondary sale of BNB.
Secondary Sale
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Late on Friday, U.S. District Judge Amy Berman Jackson ruled in the District of Columbia federal court that the SEC has made reasonable charges against Binance, Binance.US, and Changpeng Zhao, and is willing to dismiss most of the charges against these companies. However, she did dismiss the charges related to the secondary sale of BNB by non-Binance sellers, the sale of BUSD, and the charges related to Binance’s “Simple Earn” product.
Is a secondary sale also an investment contract?
One question surrounding the application of securities laws to cryptocurrencies is whether a secondary sale is also an investment contract. We have seen some rulings from district courts, but no rulings from appellate courts yet.
Judge Jackson’s ruling essentially maintains the status quo of litigation surrounding cryptocurrencies and securities – she ruled that the significant issue of principle does not apply, the SEC’s arguments (mostly) are reasonable, and there are rational reasons for the facts to make sense.
This is an interesting ruling that everyone might abide by. In a blog post on Tuesday, Binance reiterated the court’s ruling and stated that they “recognize the severe limitations of the SEC’s regulatory authority over the crypto industry.”
The judge’s ruling does allow most of the charges to proceed, including the charges related to the initial token offering of BNB and Binance’s continued token sales, BNB vault, Binance.US’s staking services, violations of the exchange act (both registration and control persons are charged), and anti-fraud provisions of the Securities Act.
I think as the case progresses, we will learn more about the debates surrounding these charges. In recent times, the judge’s ruling on the secondary sales by sellers other than Binance – she dismissed this charge – as well as stablecoins – she also dismissed a charge here – have been well received within the crypto industry.
The judge cited transcripts from multiple hearings in her ruling and pointed out that SEC lawyers stated in court that they do not believe the tokens themselves are securities, but in her view, it seems the SEC still considers that if the initial sale of a token involves marketing materials or other factors indicating it is a security, those factors will continue to apply to future sales.
“As an asset that is intended for investment contracts, the asset itself is a ‘security’ because it advances in the commercial world and is bought and sold by private parties on exchanges in any quantity and is used in multiple ways over a period of time. Indefinite term, signaling a departure from the Howey framework, which leaves no clear distinction principle between tokens in the market being securities or not, to the courts, the industry, and future buyers and sellers,”
the judge wrote.
However, the judge seems to have opened the door to other arguments surrounding secondary trading in the future, writing in the subsequent paragraphs that “more is needed” to support the SEC’s arguments about continued token sales. In fact, the judge indicates in some places that a big issue may be that the SEC currently does not have enough documents or oral arguments.
On Monday, Coinbase’s lawyers filed notice of appeal against the SEC’s case against the exchange and the exchange’s rulemaking (including Friday’s decision).
The exchange’s lawyers said in a letter to Judge Katherine Polk Failla, who oversees the SEC’s case against Coinbase, that Friday’s ruling supports an interim appeal motion – the exchange wants the appeals court to rule on how secondary trading fits the definition of “secondary trading.” Because it contradicts the SEC’s arguments against such appeals.
“Binance’s decision compounds the confusion faced by the industry and its customers. The two district courts have reached diametrically opposed views on whether these transactions, which are economically equivalent, constitute securities transactions,” Coinbase’s notice read. “The result of the SEC’s litigation-focused approach to cryptocurrency regulation is that market participants now face different rules, not only in different courts within a district but in different federal courts across the country.”
In a response on Wednesday, the SEC lawyers wrote that Friday’s ruling supported Judge Failla’s initial ruling on Coinbase’s motion and supported the dismissal of the interim appeal motion.
The SEC team wrote that Friday’s ruling highlights the role of the Howey test and that the issue of secondary trading is based on facts and circumstances.
“Moreover, including conclusions, the SEC has not sufficiently shown that certain secondary sales of BNB are investment contracts, the decision makes it clear that this decision is based on specific facts presented in the complaint,” SEC lawyers. “…contrary to Coinbase’s view, the decision does not make a general statement about whether ‘secondary market cryptocurrency trading is an investment contract under Howey’.”
The regulators said, in other words, that the ruling has no impact on the SEC’s allegations against Coinbase or the digital assets charged by the SEC in its complaint.
Other major rulings from the U.S. Supreme Court
Of course, there is a broader context to all this. In recent days, the U.S. Supreme Court has handed down three major rulings that could affect the future of the cryptocurrency industry’s relationship with federal regulators. The Supreme Court ruled in the SEC v. Jarkesy case, determining that the SEC and other federal regulators cannot use internal administrative proceedings to litigate cases.
CoinDesk’s Cheyenne Ligon reported that so far, there have not been many cases resolved through these administrative proceedings in the crypto industry, so this may not have a huge impact.
On Friday, the Supreme Court overturned the 40-year-old Chevron Deference precedent, ruling that the previous Supreme Court made an “unworkable” principle.
On Monday, the Supreme Court ruled that private groups can sue federal agencies without time limits on rulemaking, which could thwart the industry’s hope of forcing the SEC to adopt specific rules for cryptocurrencies.