On Apr. 3, 2019, the SEC Division of Corporation Finance (“Division”) issued a no-action letter to TurnKey Jet, Inc. (“TKJ”) in response to TKJ’s incoming letter dated Apr. 2, 2019. At the same time, the Division released a paper entitled “Framework for ‘Investment Contract’ Analysis of Digital Assets” (see accompanying Goodwin Blog article). The letter from TKJ described a program in which TKJ, a licensed US air carrier and air taxi operator providing interstate air charter services, proposed to offer and sell blockchain-based digital assets in the form of “tokenized” jet cards (“Tokens”). Consumers of air charter services (“Consumers”) would be able to use the Tokens to purchase such services from TKJ, third-party carriers (“Carriers”) and brokers of charter flights (“Brokers”). In the no-action letter, the Division confirmed it would not recommend enforcement action to the Commission if, in reliance on the opinion of TKJ’s counsel that the Tokens are not securities, TKJ sells the Tokens without registration under the Securities Act of 1933 and the Securities Exchange Act of 1934. The Division took particular note of the following facts (taken verbatim from the Division’s letter):
- TKJ will not use any funds from Token sales to develop the TKJ Platform, Network, or App, and each of these will be fully developed and operational at the time any Tokens are sold;
- The Tokens will be immediately usable for their intended functionality (purchasing air charter services) at the time they are sold;
- TKJ will restrict transfers of Tokens to TKJ Wallets only, and not to wallets external to the Platform;
- TKJ will sell Tokens at a price of one USD per Token throughout the life of the Program, and each Token will represent a TKJ obligation to supply air charter services at a value of one USD per Token;
- If TKJ offers to repurchase Tokens, it will only do so at a discount to the face value of the Tokens (one USD per Token) that the holder seeks to resell to TKJ, unless a court within the United States orders TKJ to liquidate the Tokens; and
- The Token is marketed in a manner that emphasizes the functionality of the Token, and not the potential for the increase in the market value of the Token.
The no-action letter to TKJ indicates that the Division will recognize at least some token programs as not involving a security but, given the fairly straight-forward circumstances of the token program at issue, it sets a low baseline. If TKJ had established the same program ten years ago with a system of credits but without using blockchain technology or the word “token,” experienced securities attorneys would not have thought they were offering securities.
We don’t know how much the TKJ facts were dictated by Division demands during the pre-letter discussion period, but we have the following observations and questions about a few of the factors that the Division cited as important to their decision in taking a no-action position::
- Use of Funds from Token Sales. When Consumers use Tokens, the funds are applied by TKJ, a Broker or a Carrier to provide services. Once the Token is “spent” to buy jet services from TKJ, TKJ should be free to use the money to further develop the Platform, Network or App as it sees fit, including expanding functionality. If imposed by the Division, this seems to be an overprotective approach imposed to ensure that funds used to buy Tokens do not constitute an investment in the design, implementation or upgrade of the Platform. If the Platform is in fact operational, we see no reason why TKJ should be limited in how it uses funds it receives in its business to make improvements to the Platform.
- Restriction of Transfers to TKJ Wallets Only. If the Token is not a security under the Howey test, it shouldn’t be necessary to prevent the Tokens from being transferred to and held by outside wallets. There may be perfectly good technology or cybersecurity reasons to allow Consumers to control how their Tokens are held.
- Repurchase by TKJ Only at a Discount. As a business matter, it would not appear to make sense for TKJ to set a condition that they will repurchase Tokens only at a discount. A rational Consumer, knowing that it could not sell Tokens back at par, would have no incentive to buy more Tokens than it needed to buy the immediately contemplated jet services. If this condition was imposed by the SEC it may have been in order to make it look less as though TKJ is supporting the value of the Tokens. However, that shouldn’t be necessary if Tokens are always worth one dollar of services. The price of services may go up and down with the charter jet market generally, but one Token will still buy one dollar of services at the market price at the time of use. As a result, other than in special circumstances, the value of Tokens is unlikely to go up or down for more than a brief period of time.
We hope that the Division will consider this a baseline case, but not the only set of facts that will support a conclusion that tokens are not securities.