Digital Assets—Investment Contracts or Howey Test Unicorns? (Part 4 of 6)

In the fourth part of his six-part series, Professor Ari Gabinet analyzes Kin’s status as a security based on the ramifications of the Howey test. Professor Gabinet draws on his expertise in securities law, accrued through experience as a private practice litigator, a private sector in-house counsel, and as a district administrator of the SEC.

Howey and the Kin TDE—The Issue of “the Efforts of Third Parties”

A central question emerges through SEC v. Kik Interactive: Did the TDE purchasers’ expectation of profit depend on Kik’s entrepreneurial or managerial efforts? If Kik’s entrepreneurial and managerial efforts were completed before the TDE, can the preceding efforts—funded with the proceeds of the private offering—be counted in the Howey analysis of the TDE? Analogizing from the orange groves in Howey is instructive: Suppose that Howey had prepared the plots in the citrus groves, but had not provided cultivation, sales and management. Rather, it had simply offered the orange groves to buyers, and put up signs inviting the public to “pick your own.” Howey could have used the proceeds of the sale for multiple purposes related to its own business— to buy more orange groves, to go into fruit retailing or other enterprises that only incidentally affect the value of the orange groves. It would seem unlikely that the sale of productive orchard land would be a security. 

If Kin’s status as a security depends on Kik’s use of the proceeds of the sale of Kin to develop the Kin infrastructure or to take steps to increase its value, and if the TDE proceeds were NOT used for that purpose, then the finding that Kin is a security depends on integrating the private offering and the TDE. This would be ironic, given that the segregation of the TDE from the private offering was done, at least in part, to ensure that the proceeds of the TDE were NOT used to create the Kin infrastructure and therefore to ensure that they were NOT securities. It is illogical—and certainly not consistent with the original purposes of integrating exempt offerings—to suggest that the offering of something which is NOT a security can be integrated with the offering of something that is a security for the very purpose of making the non-security into a security. 

Citrus groves are again instructive. If Howey had first offered citrus groves with management contracts, and then offered citrus groves without the management contracts for the owners to cultivate themselves, the second offering would be an offering of real estate, not an investment contract, and could not be integrated with earlier sales of investment contracts. If the TDE had been an offering of jellybeans, jellybeans could not become a security by integrating the sale with the private offering of Kin.

Ari Gabinet is a Senior Fellow at the Watson Institute for International and Public Affairs and the Legal Expert in Residence at Brown University. The Brown Undergraduate Law Review is grateful for his support as our Faculty Advisor.