“Define your terms, you will permit me again to say, or we shall never understand one another.” wrote the 18th century French philosopher Voltaire. This statement has as much relevancy in the modern financial markets as it did during the Age of Enlightenment. Last week, Brian Armstrong, the CEO of the cryptocurrency exchange Coinbase, publicly questioned why the Securities and Exchange Commission (SEC) threatened to sue his company for offering unregistered securities if they followed through with their new yield generating program called “Lend”. Previously, many investors had wondered why the SEC decided not to directly regulate cryptocurrencies, specifically Bitcoin. The SEC is the federal agency tasked with monitoring the country’s securities markets, but as the markets seem to offer new types of digital assets every day, what exactly qualifies as a security that the SEC should be regulating?
Following the stock market crash of 1929 and the start of the Great Depression, the federal government tried to curtail the investing excesses of the era by passing the Securities Act of 1933 which established the SEC and its regulatory purview. Now securities could not be sold to the public unless they had been registered with the SEC, had audited financial statements, and provided a prospectus to new investors. And a security was defined as anything belonging to a long list of specific products like stocks, bonds, and options, as well as more generic terms like “investment contract.” The meaning of “investment contract” was fleshed out in the 1946 Supreme Court case SEC vs. W.J. Howey Co. The Howey Co. sold tracts of Florida citrus groves to investors who then leased back the land to Howey to harvest the orange crop. The revenue generated by selling the fruit was shared by all parties. The Supreme Court determined that Howey’s arrangement was an investment contract under the Securities Act of 1933, and thus they were guilty of offering an unregistered security. The court further specified that an investment contract was “the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others”, and this definition has been parsed into four bullet points that make up the Howey test – the basic framework for determining whether a transaction qualifies as an investment contract:
1. An investment of money
2. In a common enterprise
3. With expectation of profit
4. To be derived from the efforts of others (or a third party).
Any transaction that satisfies these four points has been considered a security by the SEC, and the people creating the transaction must the spend time and money necessary to register the new security with the SEC. So does Bitcoin satisfy the Howey test? Well, it costs money to buy a Bitcoin, so point 1 is satisfied. There also is an expectation of profit, so point 3 is fulfilled. However, due to the decentralized nature of the token, there is no common enterprise nor profit to be derived from the efforts of others (the network is already set up). Thus, Bitcoin doesn’t meet the Howey test and is not a security according to a statement released by the SEC in 2019.
However, the SEC has decided that many of the products utilizing Bitcoin and other cryptocurrencies are securities according to the Howey test. For example, Coinbase’s Lend program involved customers giving Coinbase a particular type of cryptocurrency called a stablecoin ( the investment of money, since stablecoins have value) and then Coinbase pooling those stablecoins (in a common enterprise) and lending them out to other people (efforts of others) with interest that is partially paid back to the clients (expectation of profit). Defenders of Coinbase have criticized the SEC’s actions as unreasonable and its rules as archaic. Much of the foundational U.S. security law originated almost a century ago, so the need for updating as society and technology changes is always possible, but right now it is important for all market players to understand how regulators define the key terms.
Past performance is no guarantee of future results. Trend signals are proprietary research of Fortunatus Investments, LLC, a Registered Investment Advisor with the Securities and Exchange Commission (SEC). Reference to registration does not imply any particular level of qualification or skill. Prior to June 2014, Fortunatus Investments was a wholly owned subsidiary of Executive Wealth Management, LLC and they continue to share common ownership and control. Data source for returns is FactSet Research Systems Inc. This chart is not intended to provide investment advice and should not be considered as a recommendation. One cannot invest directly in an index. Executive Wealth Management does not guarantee the accuracy of this data.
Could [famous short seller] Jim Chanos just like fly in circles in a private jet while eating beef and taking long showers and saying “I am the greatest climate hero in the history of the world,” because of his short selling? Maybe?
Bloomberg Money columnist Matt Levine trying to draw the logical conclusion from the theory that the most environmentally friendly portfolio is the one with the smallest number of pollution-producing stocks. Since negative numbers are smaller than positive numbers, by the arithmetic of stock holding, those investors who short the stock of industrial, carbon-emitting companies are the financial world’s greatest environmentalists.
On A Lighter Note
Science. It scrutinizes the inscrutable and ponders the imponderable. The results of scientific studies can change the way we live and reshape how we view the world. Take for example, a recent study published in the Journal of Zoology about a particular salamander lurking in the caves of Slovenia that did not move for 7 years. The researchers believe that the slow moving waters on the cavern floor brought food to the stationary salamander during his period of inactivity. This author is so awestruck at the apathy of this amphibian that he thought this feat of lethargy should be commemorated in verse. Thus,
An Ode To A Little Lazy Salamander
Who would have thunk, while in these caves that I do spelunk,
One day I would have a gander at a little lazy salamander
They say seven years he has not moved, his stillness quite rigorously proved
But why little lazy salamander, will you not try to meander?
Maybe you’re not a mere bystander, but as wise as the old Greek Anaximander
For now is a time for silent reflection; some serious, soul-searching introspection
This inertia brings enlightenm –
Oh, wait, no, I think the little guy is just dead.
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Returns are calculated as indicated below with reinvested dividends not considered except for the Barclays U.S. Aggregate Bond Index. Data source for returns is FactSet Research Systems Inc. The London Gold PM Fix Price is used to calculate returns for gold.
1 Week = closing price on September 3, 2021 to closing price on September 10, 2021
1 Month = closing price on August 10, 2021 to closing price on September 10, 2021
3 Month = closing price on June 10, 2021 to closing price on September 10, 2021
YTD = closing price on December 31, 2020 to closing price on September 10, 2021
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