On April 3, the US Securities and Exchange Commission (SEC) provided important guidance for token issuers. The SEC Division of Corporation Finance issued a
No-Action Letter dated April 3 regarding TurnKey Jet, Inc. (the “TurnKey No-Action Letter”) in which the SEC staff confirmed that it would take no action against Turnkey Jet, Inc. (TKJ) for selling tokens without registration. This guidance is most relevant to token issuers who are focused on commercial utility and record-keeping benefits in a centrally controlled network and are willing to minimize or eliminate the profit elements of the token. The TurnKey No-Action Letter, taken together with the
Framework for “Investment Contract” Analysis of Digital Assets (“Framework”) issued by the SEC’s Strategic Hub for Innovation and Financial Technology on the same date, offers guidance for structuring the elements of a private, permissioned, centralized blockchain token and network.
[1]
The SEC staff emphasized the following elements of tokens sold by TKJ (TKJ Tokens) and the associated network in the TurnKey No-Action Letter:
- No proceeds from token sales are used to develop the network or related software;
- The network is “fully developed” and operational before tokens are sold;[2]
- When sold, the tokens are usable for their stated commercial functionality;
- Tokens cannot be transferred outside of the network;
- Tokens are sold by the issuer at a stable price throughout network operation;
- Each token represents an obligation to supply commercial services valued in a stable amount (i.e., the tokens are stablecoins);
- The issuer only repurchases tokens at a discount to their face value;[3] and
- Marketing of the tokens emphasizes their functionality, and not potential for increases in market value.
TKJ’s no-action request contains a lengthy description of the proposed network and tokens. These facts may prove significant to the SEC’s evaluation of any subsequently issued tokens seeking to rely upon the TurnKey No-Action Letter. Some features of the TKJ network and token elements that may prove significant to structuring TKJ Tokens and associated networks include:
- A network that is a permissioned blockchain, where permission is conditioned upon agreement to contractual terms and conditions;
- Fees for participation in the network are permissible;
- Distinctions among network users are possible, and may even be required to the extent individual consumers participate;
- TKJ Tokens allow the continuing active participation of the token issuer without causing the tokens to be securities, addressing a major focus of the Framework;
- The network operator satisfies applicable know-your-customer/anti-money laundering and sanctions requirements for network participants (in this case, in concert with stricter security and identity requirements for users of on-demand private aviation); and
- Token marketing materials emphasize the tokens’ consumptive use, and users represent that their purchases are for commercial use.
Of course, some of these may prove less significant than other elements not emphasized above.
Other interesting elements of the TKJ Tokens could prove significant to future responses from the SEC staff. First, the nominal asset underlying the TKJ Tokens is the US dollar, rather than a commodity or company product or service. The Framework seems to contemplate a greater variety of asset pegs, but pegs of commodities, foreign currencies, or in-kind delivery may raise greater concerns of speculative or investment opportunity and may implicate other statutory regimes.
[4] Second, TKJ commits to continuous and open-ended sales, which appears to factor heavily in its argument that TKJ tokens would have future price stability. Third, the US dollars underlying the TKJ tokens will be maintained in escrow with banks on a one-to-one ratio, and escrow balances will be subject to independent audit. The escrow arrangement contractually limits TKJ’s discretion over the use of the escrowed funds, but seemingly subjects network participants to risk of contractual breach by TKJ, and the escrowed amounts to the risk of claims by TKJ’s creditors.
[5] Finally, TKJ committed to offer no rebate, reward, bonus, or similar program. This commitment creates greater restrictions than are sometimes observed for prepaid and stored value programs.
As a product of the SEC, the TurnKey No-Action Letter does not address potential issues associated with other applicable regulatory frameworks. For example, the creation and maintenance of a centralized, permissioned blockchain operating in whole or substantial part within the United States may trigger US anti-money laundering (AML) regulations administered by the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) applicable to Money Services Businesses (MSBs)
. Notably,
administrators and
exchangers of convertible virtual currency could be viewed as a type of MSB known as a
money transmitter.
[6] Additionally, use of fiat currency to purchase a digital token of this type may be subject to rules about acting as a
provider or
seller of
prepaid access, a different type of MSB. However, the regulations contain a number of potential exemptions or limitations, which centralized, permissioned blockchain creators may be able to avail themselves of in certain scenarios. Such activity may also trigger money transmitter laws at the state-level, depending on the particular facts and circumstances.
The TurnKey No-Action Letter appears to provide a path for issuing stablecoins with potential widespread applicability as an alternative to stored value and prepaid programs without registration as securities. TKJ Tokens may provide their issuers with the following benefits, among others:
- Prepayments for products or services that provide positive cashflow (i.e., “float”);
- Avoidance of wire, credit card, and other intermediary fees;
- Avoidance of foreign exchange translation costs;
- Interest income on escrowed balances supporting token redemption obligations;
- GAAP income as fulfillment obligations are written-off for non-redemption;
- Records management efficiencies from blockchain recordkeeping;
- Transaction settlement and auditing efficiencies from blockchain recordation speed, immutability, and multiplicity;
- Processing of transactions outside of normal banking hours; and
- Smart contract implementation that may lead to reduced personnel costs and fewer commercial disputes.
On the other hand, the path represented by the TurnKey No-Action Letter may not be attractive to other types of start-up businesses and protocol developers, in particular, those intending to create protocols or networks with decentralized management and governance decision-making. In sum, the TurnKey No-Action Letter brings welcome clarity to one type of token offering—i.e., a token issued in conjunction with a developed private, permissioned, centralized blockchain network—but the Framework and guidance from other regulatory agencies is needed to understand the broader landscape of token offerings.
[1] The TurnKey No-action letter and Framework are expressions of staff views and are not binding upon the SEC. Further, the TurnKey No-action Letter is not formally applicable to any issuer other than TKJ. Nevertheless, no-action letters and staff bulletins reflect substantial deliberation by the SEC staff and in practice are often highly influential on the SEC. We therefore believe that the TurnKey No-Action Letter and Framework provide important guidance to future token issuers.
[2] While the operational element would seem to be satisfied by a network that has reached the minimum viable product stage, it is not clear whether full development is intended to represent some later stage of development.
[3] It appears that redemptions (i.e., "burns") of tokens in exchange for the underlying value can be made at par, at least to commercial users.
[4] See additional insight from Steptoe on the Framework
here.
[5] It is possible that further measures of security could affect the determination of TKJ’s counsel that the tokens are not notes under the
Reves test.
Reves v. Ernst & Young, 494 U.S. 56 (1990). However, the SEC staff’s response in the TurnKey No-Action Letter makes no mention of this issue.
[6] These regulations generally apply to the creation and issuance of tokens constituting convertible virtual currency, but may also be triggered by engaging in other activities that could be viewed as the
administration or
exchange of such tokens or currency.
