Disclaimer: what follows is my personal opinion and should not be construed as legal advice. If you are contemplating an ICO or securities transaction, it is imperative that you consult your own attorney.

In the United States, the Securities and Exchange Commission has begun issuing guidance around how cryptocurrencies being sold in ICOs are to be treated. The commissioner of the SEC, Jay Clayton, said in his February testimony to Congress, “I believe every ICO I’ve seen is a security.”

This isn’t terribly surprising. The SEC has been issuing statements that have leaned this way for several months now.

That said, many people and companies are misinterpreting what exactly a security is. I’ve encountered many examples of people positing that security tokens have to represent equity in a company (or debt or revenue shares).

That, however, is incorrect.

It makes sense why people would think that—most people are probably familiar with selling securities meaning selling stock shares in a company. But the definition of a security is actually fairly broad, and can include many more types of financial instruments.

The Securities Acts of 1933 and 1934 defined securities as:

any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security (including a certificate of deposit) or on any group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

I bolded investment contract because that is what is primarily at play when Clayton says that every ICO is selling securities.

In 1946, there was a landmark US Supreme Court case called SEC v. W. J. Howey Co. In this case, a business owned a lot of orange grove land in Florida, and they sold half of the land to investors with the promise that if the investors then leased the land back to Howey, Howey would tend it and farm the orange groves. Howey promised the investors would earn significant profits if they bought the land and followed this leasing arrangement. At no point did Howey register a security sale with the SEC.

The SEC took issue with this because they deemed these leaseback agreements as sales of unregistered securities, which was in violation of those previously mentioned Securities Acts.

The Supreme Court ultimately decided that what Howey had sold were investment contracts. That term hadn’t been defined clearly by Congress, so the Court defined an investment contract as:

a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party

This, in particular, is why the SEC has been saying that they believe all ICOs to date have been sales of securities. They believe that because crypto companies are selling tokens that the investor expects to profit on — the value of which is intimately tied to the performance of the company in delivering their product — that they are examples of an investment contract.

Note, though, that investment contracts are not shares of equity in a company. Howey was not selling equity in their company. They sold land. And yet the Supreme Court affirmed the SEC’s position that those land sales were investment contracts and thus unregistered securities.

Securities do not have to represent equity in a company. That is a very important distinction for any crypto company considering an ICO to understand.

The question of whether an ICO should register their sale with the SEC or take advantage of one of the exemptions from registration (using either Regulation D 506(c) or Regulation A+ exemptions, or perhaps something else) is an entirely different one that is up to the purveyors of that ICO and their legal representation. But if an ICO does choose to sell security tokens and follow the SEC’s guidelines for that sale, they are not required to give up equity in the company or take on debt or promise a revenue share or any other requirement people might think up.