The SEC points to BUSD, why is a stablecoin also classified as a security?
Why is the gold standard of securities, the "Howey Test," not applicable this time?Author: Loopy Lu, Odaily Planet Daily
This morning, according to informed sources, stablecoin issuer Paxos is facing a lawsuit from the U.S. Securities and Exchange Commission (SEC) due to issues related to BUSD. SEC enforcement officials have issued a "Wells notice" to Paxos, informing them of potential enforcement actions. The SEC states that the BUSD issued and listed by Paxos is an unregistered security and plans to sue Paxos for violating investor protection laws, potentially taking enforcement action.
A "Wells notice" is an informal reminder issued by the SEC to publicly traded companies before civil litigation in the U.S. Companies receiving the notice can communicate and negotiate with the SEC before a formal lawsuit is filed. John Reed Stark, former director of the SEC's Internet Enforcement Office, tweeted, "In my 18 years in the SEC's enforcement division, I don't recall ever issuing a Wells notice without taking enforcement action. The SEC's crypto actions continue."
A Paxos spokesperson declined to comment, and the SEC did not respond to requests for comment. Binance stated in a declaration, "BUSD is issued and owned by Paxos, which only licenses its brand. We will continue to monitor the situation."
According to previous reports, the New York State Department of Financial Services (NYDFS) is investigating Paxos, the issuer of Pax Dollar (USDP) and Binance USD (BUSD), although the specific scope of the investigation is unclear. A NYDFS spokesperson stated that the agency could not comment on ongoing investigations.
Unlike the long-standing SEC lawsuit against Ripple, the tokens that are rumored to be classified as securities this time, such as BUSD, which is pegged to the U.S. dollar, do not experience significant price fluctuations.
This has raised questions in the market about why stablecoins can also be classified as securities.
The SEC has not taken formal action against Paxos and has not disclosed any documents. Odaily Planet Daily has only integrated and made reasonable speculations based on existing information.
Cryptocurrency vs. Securities in the Eyes of Regulators
When mentioning "securities," it is essential to clarify the concept. The Securities Act of 1933 is the first federal law in the U.S. that regulates the issuance and sale of securities. It was initially enforced by the Federal Trade Commission, and later the SEC was established, making this act a primary basis for SEC enforcement. The act stipulates that, except for certain exempt cases, any security must be registered with the SEC.
This law also clarifies the concept of securities. Section 2(a)(1) of the Securities Act states:
"The term 'security' means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, or, in general, any interest or instrument commonly known as a 'security,' or any of the foregoing or any interest or participation in any of the foregoing."
It is clear that cryptocurrencies using emerging encryption technology are difficult to be explicitly categorized under the various products mentioned above.
However, numerous SEC lawsuits against crypto companies continue to arise.
This is because the definition of securities includes the more flexible category of "investment contracts," allowing many unspecified financial products to relate to this concept. Whether a product can be defined as a security under this clause can be determined by the famous "Howey test." In many existing judicial practices, the SEC has used the Howey test as a standard for identifying investment contracts under securities law.
Howey Test: The SEC's Main Weapon Against Crypto
In Florida in the last century, William Howey established W. J. Howey Company and Howey-in-the-Hills Service Company, developing an innovative product through these companies. W. J. Howey Company purchased a citrus grove in Florida and subdivided the land into small plots to sell to investors. He promised that investors could lease the land to Howey-in-the-Hills Service, which would operate and care for the citrus grove, allowing investors to earn profits without engaging in any agricultural production.
The SEC deemed this investment contract to be a security, and Howey had not submitted any registration statement for this unique land product to the SEC, violating securities law.
In 1946, the SEC sued W. J. Howey Company. Ultimately, after a lengthy judicial process, the U.S. Supreme Court ruled that the land sale and service contracts met the definition of "investment contracts" under securities law, meaning these contracts could be classified as securities. This case is significant for establishing the general applicability of federal securities law.
This case also led to the emergence of the Howey test, which determines whether certain investment products should be classified as securities. The SEC defines "investment contracts" as investments of money in a common enterprise with a reasonable expectation of profits derived from the efforts of others.
Specifically, the Howey test includes four elements:
An investment of money;
In a common enterprise;
With a reasonable expectation of profits;
Derived from the efforts of others.
The Howey test applies to any contract, scheme, or transaction, regardless of whether it has the typical characteristics of a security.
It is precisely based on this that many cryptocurrencies fall under the category of "investment contracts" in securities, leading to prolonged legal disputes with the SEC. In the lengthy SEC lawsuit against Ripple, the SEC used this principle to classify XRP as a security.
In July 2022, the SEC classified AMP, RLY, DDX, XYO, RGT, LCX, POWR, DFX, and KROM as securities. (Note: According to a report by The Block in July 2022, the SEC classified these nine cryptocurrencies as securities in the "Coinbase insider trading" incident.)
In November 2022, a federal court in New Hampshire ruled that LBRY was classified as a security based on the Howey test, making a ruling favorable to the SEC in the SEC v. LBRY case. (Odaily Planet Daily note: LBRY, a crypto startup, raised $11 million by selling "LBRY Credits" without conducting an ICO, and was accused by the SEC in March 2021 of acting as an unregistered broker-dealer.)
How Can Stablecoins Become Securities?
However, unlike cryptocurrencies such as XRP that have previously been targeted by the SEC, BUSD is a stablecoin pegged to the U.S. dollar, and investors do not have profit expectations when purchasing this "product." This product hardly meets any of the criteria of the Howey test; how then is it defined as a security?
Currently, the SEC has not taken formal action against Paxos and has not disclosed any documents. Odaily Planet Daily speculates:
It is important to clarify that the Howey test is merely a standard for determining the category of "investment contracts" under securities law, and in addition, more familiar financial securities such as bonds, notes, and mortgage trust certificates are also included.
Returning to BUSD, the reserve report disclosed by Paxos in January 2023 shows that BUSD reserves include two categories of products: U.S. Treasury bonds and U.S. Treasury reverse repurchase agreements (overnight maturity and over-collateralized).
This holding structure makes it more like a money market fund, meaning that BUSD users indirectly hold bonds (which are one category of securities). We can speculate that this may be the reason the SEC classifies BUSD as a security.
However, users holding BUSD, while purchasing a product similar to a money market fund (BUSD), do not profit from it.
The SEC's enforcement actions are poised to strike, but their impact has yet to be reflected in the market (BUSD remains pegged, and BNB performs strongly in today's overall declining market).
Nansen data shows that the current total market capitalization of BUSD is $16 billion, ranking it third among stablecoins. Approximately 90% ($14.4 billion) of BUSD is held by Binance addresses. In the past seven days, Binance has seen a net outflow of over 81.4 million BUSD. Additionally, a certain address from Jump Trading has withdrawn a net of 57.8 million BUSD from the exchange in the past seven days, and that address still holds 18.8 million BUSD.
