In his famous 2018 speech, William Hinman, Digital Asset Transactions: When Howey Met Gary (Plastic) (1), the Director of the U.S. Securities and Exchange Commission (“SEC”), asked: 

"Can a digital asset that was originally offered in a securities offering ever be later sold in a manner that does not constitute an offering of a security?” In cases where the digital asset represents a set of rights that gives the holder a financial interest in an enterprise, the answer is likely “no.” In these cases, calling the transaction an initial coin offering, or “ICO,” or a sale of a “token,” will not take it out of the purview of the U.S. securities laws (2). 

Hinman went on to note:

But what about cases where there is no longer any central enterprise being invested in or where the digital asset is sold only to be used to purchase a good or service available through the network on which it was created? I believe in these cases the answer is a qualified “yes.” (3)

Apparently, New York Attorney General Letitia James and her team disagree.

James recently announced a sweeping enforcement action against digital currency exchange KuCoin. In the petition, James alleged that KuCoin violated New York’s Martin Act, the state’s “blue sky” securities law, by (i) selling and purchasing securities and commodities without being registered as a New York commodities broker-dealer or securities broker or dealer, (ii) issuing “KuCoin Earn,” a proprietary savings and staking token, which the state's attorney general considers an unregistered security, and (iii) falsely holding itself out as an exchange (4). New York investigators claim to have created and used a KuCoin account using a New York IP address even though KuCoin is not registered to operate in New York. Specifically, James alleges that KuCoin collected transaction fees from purchases and sales of digital currencies Ethereum, Luna, UST, and KuCoin Earn, all of which the NYAG deems commodities and securities. The New York attorney general’s action follows KuCoin’s failure to provide testimony in compliance with a January 2023 subpoena. Also worth noting is the attorney general's reliance on SEC v. LBRY, Inc., a recent decision in which a federal district court applying the Howey test found that statements characterizing a token as an investment with growth potential tied to its founders’ futures weighed in favor of a finding that the token at issue was a security (5). The New York attorney general office cited LBRY in concluding that Ethereum, Luna, and UST are securities under New York law.

In a first-of-its-kind move, James went further by arguing that Ethereum, one of the world’s most valuable and frequently traded digital currencies, constitutes a security under New York law. This classification comes just days after Commodity Futures Trading Commission (CFTC) Chairman Rostin Behnam reaffirmed in Senate testimony the CFTC’s position that Ethereum is a commodity (6). SEC Chairman Gary Gensler, however, recently opined that “[e]verything other than bitcoin” was within the SEC’s jurisdiction, subtly signaling the SEC’s evolving, more aggressive posture with respect to Ethereum (7). By arguing that Ethereum constitutes both a security and commodity, James fanned the flames of an ongoing debate over Ethereum’s regulatory future and introduced a third, novel approach. Shortly after the state’s attorney general office made the announcement, Ethereum’s value declined by more than 8%. 

The New York attorney general’s position that Ethereum is a security is contrary to Hinman’s opinion, when he was the head of the SEC Division of Corporation Finance that as of the date of his speech Ethereum was sufficiently decentralized so as to not be a security. In his speech, Hinman noted:

And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value. Over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required. And of course, there will continue to be systems that rely on central actors whose efforts are a key to the success of the enterprise. In those cases, application of the securities laws protects the investors who purchase the tokens or coins (8). 

While the Hinman speech has become a subject of contention in the SEC’s enforcement action against Ripple, it appears James and her team appear disagree with Hinman’s view that Ethereum is not a security.

The New York attorney general’s position that Ethereum is a security is consistent with Gensler’s view on the subject before he joined the SEC. In a 2018 interview with the New York Times, Gensler noted:

the second and third most widely used virtual currencies, Ether and Ripple, have most likely been issued and traded in violation of American securities regulations.

“There is a strong case for both of them — but particularly Ripple — that they are noncompliant securities,” he said [he] believes Bitcoin, the original virtual currency, can remain exempt from securities regulations (9). 

We anticipate the parties will issue of whether Ethereum and the other digital assets identified in the complaint will be deemed securities under New York’s Martin Act. The complaint against KuCoin does not address whether the offer and sale of Ethereum and the other digital assets is barred by the applicable [three-year] statute of limitations of in New York.

James seeks to permanently enjoin KuCoin from selling and buying securities and commodities in New York, a detailed accounting of KuCoin’s transactions, and payment of restitution and disgorgement of all revenue obtained through allegedly illegal conduct. This action is the latest in James’ ongoing campaign to rein in what her office has characterized as “shadowy” players. Just last month, for example, James brought a similar enforcement action against CoinEx, a much smaller exchange.

Participants in the digital asset industry that have, or wish to establish, a presence in New York should proceed with caution. Like Gensler, James has adopted a position that could be used to argue that nearly all digital assets are securities.

FOOTNOTES

(¹) Hinman, W., Digital Asset Transactions: When Howey Met Gary (Plastic) (June 14, 2018), available at: https://www.sec.gov/news/speech/speech-hinman-061418. 

(²) Id. (emphasis added).

(³) Id. (emphasis added).

(⁴)https://ag.ny.gov/sites/default/files/2023.03.09_-_memorandum_of_law_-_people_v_mek_global_limited_and_phoenixfin_pte_ltd_dba_kucoin.pdf.

(⁵) No. 1:21-cv-00260-PB (D.N.H. Nov. 7, 2022). 

(⁶) Behnam, R., Testimony of Chairman Rostin Behnam Before the U.S. Senate Committee on Agriculture, Nutrition, & Forestry (Mar. 8, 2023), available at: https://decrypt.co/123032/cftc-chair-says-ethereum-is-a-commodity-despite-genslers-bitcoin-only-position.

(⁷) https://nymag.com/intelligencer/2023/02/gary-gensler-on-meeting-with-sbf-and-his-crypto-crackdown.html.

(⁸) Hinman, W., Digital Asset Transactions: When Howey Met Gary (Plastic) (June 14, 2018), available at: https://www.sec.gov/news/speech/speech-hinman-061418.

(⁹) Popper, N., A Former Top Wall Street Regulator Turns to the Blockchain, New York Times (April 22, 2018), available at: https://www.nytimes.com/2018/04/22/technology/gensler-mit-blockchain.html.