[DRAFT]
This structure would employ a Reg D 504 or 506(b) offering of a #blockchain based investment contract by a for-profit entity to investors. The for-profit would intentionally wind up and dissolve after creating a blockchain-based solution, complete with tokens, using the funds from its investment round. Just prior to dissolution, the for-profit entity would donate its tokens to a non-profit. The non-profit would then, pursuant to legal arrangements between the for-profit and the investors and the for-profit and the non-profit, host a traditional (not Dutch) auction sale of the donated tokens. The non-profit would use those funds to carry on its mission, which would not involve exercising any control over the supply of tokens or the blockchain. The founders and developers would retain tokens as payment by the for-profit entity for their services in creating the solution, and they would have no affiliation with the non-profit.
The aforementioned structure and the below outline for a [Persuasive Document] is obviously not legal advice, and should not be taken, interpreted, or viewed as such, nor should it be relied upon as an expression of any sort of opinion, legal or otherwise, about the legality of this structure or the accuracy of this analysis. The regulatory environment is rapidly changing and anyone operating in this space should seek legal counsel before doing anything. That being said, I would be happy to recommend knowledgeable and reputable legal counsel to any Truly Virtuous Token.)
Application of the Howey Test
SEC v. W.J. Howey Co., 328 U.S. 293 (1946), defined “investment contract” as a contract, transaction or scheme in which (1) a person invests money in a common enterprise; (2) with a reasonable expectation of profits; (3) to be derived from the entrepreneurial or managerial efforts of others.
Because the investors who purchase the [TOKENS] at the “auction” will be able to determine the price of the [TOKENS] by bidding on them, they will be, in practical effect, recognizing the entrepreneurial or managerial efforts for which they’ve already paid prior to the auction. They will therefore be, in other words, determining their own profits. For example, if the total amount spent on investment contracts (which I will call "tickets" [as in "admission tickets to the auction"]) (my understanding is that auctions are not federally regulated; they are regulated by the states a la U.C.C.). is $1 million, then whether the investors actually earn a profit from the work of the [NAME] team will depend on whether the bidding renders the value of [TOKENS] in excess of $1 million (note: this amount will likely be Fair Market Value (see p. 2 in the foregoing link)).
Once the bidding is complete, the investment contracts (which I call "tickets") and the for-profit entity, cease to exist. The value of the tokens, which was initially determined by the bidding (and not the cost of developing the network), will be completely governed by the future demand of the tokens. The future demand of the tokens will be dependent upon the initial investors’ use of the network.
The non-profit will function to: (1) educate companies, specifically other non-profits, on how to properly use the network; (2) pay bounties; (3) help moderate disputes among users; and (4) develop uses of the network for other non-profits. However, were the non-profit to no longer exist, the users of the network would likely assume this role anyhow; in fact, it is presumed they eventually will. The value of the tokens is, thus, not derived from the non-profit’s existence, just as it would not be derived from a common investment by the users in ensuring the integrity of the system.
The profits are derived from the users continuing to use the network and build upon it.
In the SEC’s DAO opinion (see also this Investor Bulletin), it noted that Slock.it led investors to rely on their significant managerial efforts because Slock.it: (1) created the DAO website; (2) marketed the DAO; (3) created the White Paper; and (4) held themselves out as experts.
Slock.it then actually engaged in managerial tasks by: (1) determining the DAO’s protocols, including, most importantly, choosing the individuals who would serve as Curators; and (2) actively overseeing the DAO by monitoring the network and addressing problems.
Also significant was the fact that Slock.it created the DAO as a for-profit entity.
The non-profit will make clear to investors that the [NAME] network is an open-source network and the for-profit entity seeks only to profit from the value it creates upon donating its creation. The for-profit will do the same, in its disclosures and in its White Paper.
The non-profit will exist only to further facilitate the self-sustaining network by educating companies on how to use the network. The non-profit will have no control over the network, but it will serve to keep the network healthy if the companies neglect their roles.
The [NAME] non-profit is markedly distinguishable from Howey-in-the-Hills, from the seminal Howey case, in substantive ways as well. Howey-in-the-Hills was a service company engaged in cultivating and developing many of the groves that the investors inHowey purchased. Pursuant to the service contract between the investors and W.J. Howey Company (the seller of the groves), Howey-in-the-Hills had a leasehold interest in the groves and "full and complete" possession of the acreage, so that Howey-in-the-Hills could service the land.
The Supreme Court recognized that the investors in Howey were purchasing more than fee simple interests in land. The Court appreciated that the investors had “no desire to occupy the land or to develop it themselves.” Instead, the investors were “attracted solely by the prospects of a return on their investment” because the “common enterprise managed by respondents or third parties with adequate personnel and equipment [was] essential” to their profits.
The [NAME] non-profit is not essential to the functioning of the [NAME] blockchain because the investors will have both the desire and the capability to develop individual uses of the [NAME] network completely independent of the non-profit and the other investors. The non-profit will exist to support the companies, and to a certain degree the network as well, but no more so than any other individual or entity in the open source world.
(To draw an analogy, considering the non-profit to be legally essential to the functioning of the network would be like considering plumbers to be essential to the price of pipes used for plumbing.)
[TOKENS] are not securities for four reasons:
The purpose of [TOKENS] is to be used to create contracts on the [NAME] network. They are not intended to function as a security or an investment in any particular entity; rather, investing in [TOKENS] would be an investment in the users of [TOKENS], or in the network itself.
The initial value of [TOKENS] is determined entirely by the investors, based on how they plan to use the [TOKENS] and how they expect other entities will use [TOKENS]. And, of course, the value of the network is separate from the tokens themselves
The future value of [TOKENS] is determined by the market demand for [TOKENS], as their function remains exactly the same as it was when they were minted
Investors’ efforts, not the issuer’s or the non-profit’s, determine the value of [TOKENS] because the investors develop on the network. Engagement by users, and their own entrepreneurial and managerial efforts of their applications, will determine the value of the tokens, nothing else.
The following three reasons support the determination that [TOKENS] are commodities:
The issuer of the [TOKENS] does not seek to profit from use or development of the [NAME] Network because it will cease to exist (the good is independent of the company)
Neither the Non-Profit nor the users of the [NAME] network will benefit from [TOKENS] increasing in value (only speculators have something to gain)
The auction of the [TOKENS] is what assigns them market value, and it would be impossible for investors to plausibly value a security issued by a company that plans to dissolve
Even if [TOKENS] were securities upon issuance, they would still become commodities once issued to initial investors. The non-profit, which would likely take an exemption under the Philanthropic Protection Act, could potentially broker/deal of securities without registering. Thus, if [TOKENS] are still considered securities when they are donated to the non-profit, the non-profit is allowed to exchange them for capital. (It will need to get the blockchain solution and the tokens appraised separately, and there will be complicated tax calculations stemming from business decisions.)
Once sold, however, the [TOKENS] certainly become commodities because they serve only one utility: permission to build on the [NAME] Network. As mentioned above, the trading of [TOKENS] on the secondary market does not benefit the non-profit whatsoever. The price of [TOKENS] on the secondary market is influenced by profit-seeking market actors who create network value by continuing to develop applications and use [TOKENS]—not by the non-profit who, at best, creates value by supporting some of those companies.
(The intent of the non-profit to eventually turn over its support and maintenance roles to users of the network so that it can pursue other aspects of its mission would be further evidence of how little its efforts affect the price of the [TOKENS]).
(E.E.M.)
