Coinbase, the cryptocurrency platform, has received a Wells Notice from the SEC regarding its lending program.
SEC vs. Howey
Howey is the seminal Supreme Court case defining what is a security. In simple terms, according to Howey, a security is an investment of money in a common enterprise, with the expectation of making a profit from the efforts of others. In an oversimplification, stocks, bonds, and promissory notes with a term of more than nine months, are all securities, and subject to SEC regulation.
Reves vs. Ernst & Young
Since there are types of notes which, under a traditional Howey analysis, may not be deemed “investment contracts” but still bear a resemblance to a security, the Supreme Court in Reves v. Ernst & Young, set forth the “family resemblance” test to determine whether a note is a security.
First, we examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it. If the seller’s purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a “security.” If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller’s cash-flow difficulties, or to advance some other commercial or consumer purpose, on the other hand, the note is less sensibly described as a “security.” Second, we examine the “plan of distribution” of the instrument to determine whether it is an instrument in which there is “common trading for speculation or investment.” Third, we examine the reasonable expectations of the investing public: The Court will consider instruments to be “securities” on the basis of such public expectations, even where an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not “securities” as used in that transaction. . . . Finally, we examine whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary.
Is The Coinbase Lend Program a Security?
While the details of the program have not been released, it seems that Coinbase’s lend program is not a security under Howey or Reves. Using the Reves analysis, the loan, or note, is not being used to finance a substantial investment. Rather, the loan, or note, is provided to advance a consumer purposed, i.e. to enhance the return on the lender’s separate investment.
Regulation by Litigation