SEC says tokenized securities remain subject to federal securities laws

The US Securities and Exchange Commission (SEC), together with the Division of Corporation Finance, Division of Investment Management, and Division of Trading and Markets, which provided their views, just issued a joint staff statement on tokenized Securities. 

The guidance hopes to provide clarity amid the growing interest in tokenization from tradfi institutions. 

According to the statement, tokenizing a security does not alter its legal status under federal securities laws. It is crucial to note that the format or technology used does not matter; a security is a security if it meets the definition under laws like the Securities Act of 1933 or Securities Exchange Act of 1934. 

SEC clarifies tokenized securities status 

In the statement, a tokenized security is defined as a financial instrument enumerated in the definition of “security” under the federal securities laws that is formatted as or represented by a crypto asset, where the record of ownership is maintained in whole or in part on or through one or more crypto networks. 

There are various models used to tokenize securities, all of which vary in terms of structure and the rights afforded to holders. However, they generally fall into two categories: 

• Securities tokenized by or on behalf of the issuers of such securities
• Securities tokenized by third parties unaffiliated with the issuers of such securities

The first model, the issuer-sponsored model, involves the issuer directly tokenizing the security or authorizing it, then integrating blockchain records into official ownership tracking. It can be seen as true direct ownership. 

The second model involves securities created by unaffiliated third parties. Such securities provide synthetic or indirect exposure, and according to the SEC, these face the same scrutiny and may carry extra risks like counterparty issues. 

The statement agrees that innovation is possible, but must not come at the cost of investor protection and compliance. It builds on prior SEC discussions regarding tokenized securities and how they are still securities. There have also been related actions, like the no-action relied on for companies like the Depository Trust Company (DTC) on tokenization pilots. 

The SEC’s posture on crypto enforcement has also continued to shift 

Aside from all the clarity the SEC has been working to incorporate as the crypto sector continues to intersect with the traditional systems, the agency has also been undergoing a reorientation that has changed how it handles crypto enforcement. 

One of the biggest proofs of this pivot has been the recent high-profile cases the SEC has put down one after the other. The most recent among them involved the Winklevoss twins’ Gemini Trust Company, related to its now-defunct Gemini Earn lending program. 

The dismissal of the case happened with prejudice, which means the SEC cannot refile the same claims at a future date. The agency had initially charged the company in January 2023 for reportedly offering and selling unregistered securities via Gemini Earn.

The program allowed users to lend their crypto assets to Genesis for yield, but when Genesis froze withdrawals amid 2022’s market crash, Earn users lost access to funds for over a year, which was what got the SEC involved. 

The agency accused Gemini of failing to register the offering, and according to a joint filing, has decided to dismiss the case upon the full recovery of the original crypto assets users had lent to Genesis. This was made possible through the Genesis bankruptcy process as well as related settlements, which set the stage for the repayment of users that occurred this year.

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