I. Background
On February 27, the staff of the Division of Corporation Finance (the “Staff”) of the Securities and Exchange Commission (“SEC” or “Commission”) released a statement concerning meme coins (“Statement”) with the stated purpose of providing “greater clarity” to market participants.1 The Statement contains a description of meme coins, and the Staff ultimately concludes that transactions in “the types of meme coins described in this statement” do not involve the offer and sale of securities.2
As a result, while the Statement had the goal of providing greater clarity about the application of the federal securities laws to meme coins and may provide some comfort for market participants transacting in meme coins of the type described in the Statement, a number of questions remain. This alert describes the Statement and some of the remaining open questions regarding the treatment of meme coins. In addition, we highlight additional regulatory considerations for market participants transacting in meme coins, as well as potential civil liability.
II. Staff Guidance
The Statement was issued “as part of an effort to provide greater clarity on the application of the federal securities laws to crypto assets.”3 The Statement describes a specific type of meme coin and then concludes that transactions in “the types of meme coins described in this statement” do not involve the offer and sale of securities.4
The Statement describes a meme coin as a “type of crypto asset inspired by internet memes, characters, current events, or trends for which the promoter seeks to attract an enthusiastic online community to purchase the meme coin and engage in its trading.”5 The Staff explains that many of these assets possess similar qualities, and the Statement applies to meme coins that share the following characteristics:6
- They are purchased for entertainment, social interaction, and cultural purposes;
- Their value is driven primarily by market demand and speculation;
- They have little-to-no functionality;
- Their prices tend to be significantly volatile; and
- They often feature disclaimers concerning their limited usefulness and associated risks.
These types of meme coins, according to the Statement, are not securities for two reasons. First, a meme coin does not constitute any of the financial instruments enumerated in Section 2(a)(1) of the Securities Act of 1933 (the “Securities Act”) and Section 3(a)(10) of the Securities Exchange Act of 1934 “because, among other things, it does not generate a yield or convey rights to future income, profits, or assets of a business. In other words, a meme coin is not itself a security.”7 Second, because a meme coin itself is not specifically listed as a security in the statutes, the Staff analyzes whether the meme coin can be offered and sold as a security under the “investment contract test” set forth in SEC v. W.J. Howey Co.8 The investment contract test analyzes “whether certain arrangements or instruments are investment contracts based on their ‘economic realities.’”9 Under the Staff’s Howey analysis, the offer and sale of these meme coins does not create an investment contract because, amongst other reasons, it does not involve an investment in a “common enterprise,” and there is no corresponding reasonable expectation of profits derived from the efforts of others.10 In reaching this conclusion, the Staff notes that “the value of meme coins is derived from speculative trading and the collective sentiment of the market, like a collectible.”11
Based on the Staff’s views, transactions “in the types of meme coins described in [the Statement]” do not need to be registered with the Commission under the Securities Act, and “neither meme coin purchasers nor holders are protected by the federal securities laws.”12 However, meme coins that are not of the type described in the Statement can still be securities, and the offer or sale of such coins may be subject to the federal securities laws.
In addition, there are a number of limitations or caveats described in the Statement of which market participants should be aware. First, the Staff notes that “the statement is not a rule, regulation, guidance, or statement of the [Commission], and the Commission has neither approved nor disapproved its content. This Statement, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.”13 Second, the Staff states that “[t]he Division’s view is not dispositive of whether a specific meme coin itself is a security or whether it is offered and sold as part of an investment contract, which is a security. A definitive determination requires analyzing the specific facts relating to the meme coin and the manner in which it is offered and sold.”14 Accordingly, market participants should carefully review the Statement and perform the necessary fact-specific analysis to be certain whether a meme coin is within the scope of the Statement. Market participants should also take note that the Statement does not extend to products labeled as meme coins “in an effort to evade the application of the federal securities laws by disguising a product that otherwise would constitute a security,” and that although the offer and sale of meme coins may not be subject to the federal securities laws, “fraudulent conduct related to the offer and sale of meme coins may be subject to enforcement action or prosecution by other federal or state agencies under other federal and state laws.”15
III. Other Regulatory Considerations
Market participants should be aware of the guidance regulators other than the Staff have issued about meme coins. For example, the New York Department of Financial Services (“NYDFS”) recently published a consumer alert concerning meme coins and noted it is “closely monitoring the recent, and rapid, proliferation of sentiment-based virtual currencies, commonly referred to as ‘meme coins (“NYDFS Alert”).’”16 The NYDFS Alert does not opine on whether meme coins constitute securities, but it warns consumers that these coins “present exceptional risk of fraud and loss of funds.”17 According to the NYDFS, many of these coins are thinly traded and involve concentrated ownership.18 As a result, they may be part of “rug pulls” or other schemes that benefit promoters and lead to price crashes.19 Accordingly, market participants subject to NYDFS jurisdiction should keep the NYDFS Alert in mind when offering these products to consumers, and more broadly market participants should closely monitor for additional meme-coin related alerts or guidance issued by other state or federal regulators.
IV. Other Potential Sources of Liability
When transacting in meme coins, market participants should be aware of potential civil liability. Private civil litigants have brought actions alleging violations of federal securities laws in connection with the offer and sale of meme coins. For example, Pump.Fun, a decentralized finance platform that facilitates the creation and sale of meme coins, was recently the subject of two class actions filed in the U.S. District Court for the Southern District of New York.20 The plaintiffs in these cases, purchasers of meme coins who suffered losses, allege that the meme coins at issue are unregistered securities, and that Pump.Fun sold, promoted, or solicited the sale of these assets in violation of the Securities Act.21 The complaints also allege that Ponzi and “pump and dump” schemes are “inherent to [Pump.Fun’s] operations.”22
Similarly, private litigants have also sued meme coin promoters.23 For example, after a token lost 90% of its market capitalization shortly after its launch, twelve investors sued the token’s promoters for violations of Sections 5 and 12(a)(1) of the Securities Act.24 In the complaint, plaintiffs allege that the promoters leveraged social media and an extensive marketing campaign to create a reasonable expectation of profits among investors.25 Accordingly, market participants should consider the risks of private lawsuits, as well as state and federal enforcement, before engaging in transactions involving meme coins.
The Statement is likely to have little, if any, bearing on private securities claims. Courts have reserved the right to interpret the federal securities laws for themselves in private securities cases regardless of even formal Commission interpretations.26 The Statement sets forth only the Staff’s “views,”27 not the Commission’s interpretation, so it will be useful in a civil litigation only to the extent the court finds the Staff’s analysis both persuasive and applicable to the meme coin at issue. At bottom, a litigant is free to commend the Staff’s analysis to a court, and the opponent is equally free to refer the court to Commissioner Crenshaw’s response. And as the Statement implicitly acknowledges, even if a particular meme coin is not a security, remedies may still be available under other federal statutes and under state law.
