Why is Crypto Asset “EMAX” classified as a security in Kardashian case?

Crypto Asset “EMAX” classified as a security in Kardashian case

On October 3, 2022, the SEC settled a case against celebrity icon Kim Kardashian for promoting a crypto asset (EMAX) without disclosing that she was getting paid to do so. She was fined $1.26 million in “penalties, disgorgement, and interest.” A news release on the case also stated that she’s agreed to cooperate with the SEC’s “ongoing investigation.”

Athletes Antonio Brown, Paul Pierce, and Floyd Mayweather Jr. have also been named in the lawsuit, but they aren’t headliners. Kim Kardashian has 331 million Instagram followers. Anything she does is a top story on celebrity gossip sites. This case was a lead on mainstream and financial news networks. Who benefitted the most from that?

SEC Chair Gensler calls EMAX a security

Former SEC Chair Jay Clayton set a precedent in a 2018 CNBC interview when he clearly stated that Bitcoin (BTC) is not a security. Gary Gensler, who was a former CFTC chair at the time, had just come down hard on Ripple (XRP), declaring that there was a “strong case” to classify them as a security. Policy makers at the SEC have been wrestling with the question ever since.

Gensler, who is now the SEC chair, has stated that the grounds for the Kardashian lawsuit are “a failure to disclose to the public when and how much she was paid to promote investing in securities.” Are EMAX and XRP somehow different from Bitcoin? This is a complicated question that we’ll attempt to explain in the next section. Buckle up. It’s a bumpy ride.

Using the Howey Test to evaluate Cryptocurrencies

The SEC’s litmus test for securities comes from a 1946 Supreme Court case titled SEC v. W.J. Howey Company. The premise was the Howey Company sale of citrus groves to buyers in Florida. They sold the land, then had it leased back to them so their employees could work it and sell the fruit on behalf of the new owners.

The SEC sued, claiming that the Howey arrangement qualified as an (unregistered) investment contract. The Supreme Court came back with new criteria to define exactly what that meant. Their definition, known as “The Howey Test,” is the guideline being used by the SEC today to evaluate cryptocurrency. There are four components to it:

  1. An investment of money
  2. In a common enterprise
  3. With the expectation of profit
  4. To be derived from the efforts of others

Crypto is an investment of money in a common enterprise. That’s fairly clear. It’s when you get to “expectation of profit to be derived from the efforts of others” that this gets a little murky. With Bitcoin, there are no “others” to put effort into it. The crypto asset BTC is completely decentralized and essentially just an algorithm. It’s therefore not an investment contract, aka security.

Despite the name similarity, Ethereum Max is not affiliated with Ethereum (ETH), which should be in the same (non-security) category as Bitcoin. EMAX works differently. There is a team behind the scenes pushing merchandise, hustling games of chance, and “burning” tokens to manipulate the value. That activity, in the eyes of the SEC, makes them a security.

Legislation stalls as SEC voices get louder

EMAX might not pass the Howey Test, but there are still no official guidelines on cryptocurrency classification. Discussions around the “Digital Commodities Consumer Protection Act” (DCCPA) have stalled in the US Senate as we get closer to election season. Meanwhile, the SEC is pushing their “security agenda” through celebrity social media. The loudest voice seems to be winning.

How does this affect serious investors? EMAX holders got a nice 50% price boost when the story first broke. Trading volume also went up, but it’s difficult to attribute that directly to the Kardashian case. The rest of the crypto space is just watching and waiting. What we’re seeing now is politics and positioning. Real changes likely won’t come until next year.

Ask Your Tactive Advisor about Crypto Assets

Tactive advisors embrace holistic investment strategies that incorporate all asset classes, not just stocks and bonds. Contact your advisor today to ask about crypto assets, real estate, insurance, and other alternatives. The world has changed. How we think about investment returns needs to change also. Keep an eye on this space to learn more about that.