Things That Are Not Securities
This post is about things that are not included in the SEC’s definition of Securities. I am not a lawyer and this is NOT an analysis of Current Art in Securities Law. The purpose of this article is to identify things that are definitely not securities according to the SEC, with a rudimentary understanding of the law in mind.
Trigger Warning: I express opinions that favor decentralization and demonopolization, and that may be seen as an existential threat to entire industries (and therefore individual livelihoods). If these ideas make you uncomfortable then I recognize your right to feel offended but will not curtail my opinions on your behalf.
Federal Laws in the USA are documented (i.e., codified) in The Code of the Laws of the United States of America. Opinions about how to interpret these laws (or, how to decode them) is provided by various governmental and quasi-governmental organizations. Commissions and Enforcement Agencies are part of this group and provide specific guidelines and make decisions that inform what is the current art in operating within the law.
The Securities and Exchange Commission (SEC) is responsible for working with the Federal Bureau of Investigations (FBI) to guide enforcement of laws¹, as well as ancillary rules and regulations, so that they can “protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The SEC strives to promote a market environment that is worthy of the public’s trust.”² The mission is a string of terms that need to be defined, and these definitions are what we would call gray areas. We’ll get to that later, but at some point to understand the law we’ll need definitions for “investors,” “markets,” “capital,” “formation” and “public trust” including the measurement thereof.
We can therefore decode the law and act within the law as long as we do NOT:
- harm investors
- disrupt markets or make them inefficient
- make capital formation harder
- cause the public to distrust the market
Furthermore, there is a legal construct called the Howey Test that is a guideline to how the SEC might treat a contract between two or more counter-parties in classifying something as a security.
The Howey Test is an analysis of the Thing Being Sold, as well as How the Thing Is Sold. There is an in-depth article here on sec.gov, which in my opinion fails to understand the technological movement underfoot and is one reason for this article.
Baseball Cards are Not Securities
Baseball cards are the archetypical tradable limited supply item.
Baseball cards have always been marketed as Limited Supply Items to be collected and traded. The purpose (i.e., utility) of the cards is that you possess at your fingertips information about the player and a picture as well. There is an implicit understanding that the cards have limited supply, but in the early days there was no information to prove this, nor were there serial numbers or other information to indicate how limited the supply really was. Having more than one card gave you additional utility as you could then start to compare players in your collection; if you joined up with friends who also had cards then you had more information at your fingertips, and you could (for whatever purpose) rebalance your collection by trading cards with other card-holders.
How were they sold? Well, you had to mine them. You bought a packet of bubble gum (a mining stake) and you were not aware of the specific cards that were in the packet, although you were promised that there would be cards enclosed. You purchased the packet of gum, and immediately opened it afterwards to see what cards you had just bought. One might argue that you bought gum, and that the cards were a free gift, but the price of the baseball-card-carrying-gum was higher than other gums without cards so the notion that cards were zero cost is easily disproved.
What information did you have when deciding to purchase a packet, and what were the expectations of the buyer? I recall, as a youngster, hoping for cards that I knew were in limited supply, and that had players whom I liked or who were performing well. For example, finding a rookie card and then having the rookie’s performance skyrocket would be a great find, as would finding a new card from an aging veteran on my home team (although in Nolan Ryan’s last couple of years they printed a TON of his cards). So, my expectations were that I might find something valuable or something that would become valuable. The value would be extracted via multiple events, some of which were under the control of the card publisher and others outside of the control of the managers of the supply chain. My dog could eat it, for example. Or a high-flying player could crash his Lamborghini Countach into a tree, which gave us real world lessons in supply and demand.
If I didn’t like what I received, or if by chance I found a real gem, what could I do about it? I had two immediate liquidity options at the time as eBay wasn’t around (apologies for a minor mind explosion if you dig), which were 1) my friends and 2) the local baseball card shop(/dealer). Non-immediate options were a convention in a big city where thousands of card-holders would congregate, or one of several burgeoning mail-order and magazine-based services. The point is there were several levels of markets operating with roles played by participants in those markets: HODLers, speculators, brokers, con artists, industry pundits and local peacekeepers. Collectively, these participants were DEFINITELY operating a functioning market treating baseball cards as tradable things with swappable value to real money. As an owner of cards I was not aware of a government organization that cared or would be there to help if I was scammed, and therefore wouldn’t think the local police would care if my cards were stolen or if somebody sold me a counterfeit. There wasn’t a Baseball Cards Exchange Commission (BCEC) to my knowledge.
Much of the current art in securities law is time-dependent and there are informal limitations on statute enforcement. Perhaps today, baseball cards would in hindsight be considered securities.
Maybe, Ether ($ETH) on the Ethereum mainnet would be considered a security too — which it is not. But Ropsten or Goerli wouldn’t, would they? Right?
Definitions
Securities are traded on Markets, or the SEC would have nothing to regulate. However, the SEC allows securities to be traded off-market or over the counter (OTC) as long as the counter-parties agree to follow certain rules and regulations. Retail investors are not invited to these counter-parties.³
But Markets can sell things that are not securities, or in other words just because it’s traded doesn’t make it a security. $ETH on Etherscan.io Main Network might be deemed a Market but then so too would be the entire Internet; so that won’t be a sufficient delineation. The current Decentralized Exchanges certainly look like markets in that they facilitate market activity — i.e., placing Ask Prices to sell things you have and/or placing Bid Prices to buy things you want, in some sort of swap contract (a trade agreement) — but there is no throat to choke. The power of decentralization means that the only enforcement the SEC can perform is vis-a-vis individual participants, and it cannot regulate the actions of individuals by affecting the operations of a central market operator.
Remember when the government didn’t do anything about Napster and supposed intellectual property theft therein? Well, you can thank Metallica for being the SEC of the Music Industry, and for creating opportunities for collective mind-control by pushing the Napster founder Sean Parker and investors straight at the Zuck. Anti-Decentralization has its consequences.
The question is, are all things traded on Decentralized Exchanges securities or are they just baseball cards?
If you’d like to consider something similar to baseball cards but different in their utility, check out MAGIC Cards.
Here’s a list of other things that would be fun to analyze in this context:
Gold is Not a Security and neither is a Diamond
Art is Not a Security
Real Estate is Not a Security
… But a Real Estate Trust IS a Security
Stamps are Not Securities
… wait, What??!!
I encourage you to go back and read that SEC page again. Enjoy!
A Closing Thought
Nobody is forcing anyone to participate in decentralized markets, and everyone is free to continue to pay rent to the intermediaries for as long as they like. The SEC is ostensibly there for our protection as a society because capital formation is indeed important, but who are they REALLY protecting?
Footnotes
- The specific laws under the SEC’s remit are:
- Securities Act of 1933
- Securities Exchange Act of 1934
- Trust Indenture Act of 1939
- Investment Company Act of 1940
- Investment Advisers Act of 1940
- Sarbanes-Oxley Act of 2002
- Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
- Jumpstart Our Business Startups Act of 2012
- Rules and Regulations
2. sec.gov home page
3. Official Submission for worst Dad+Finance joke of 2021
