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Bitcoin as a Security traded on the Securities and Exchanges Market Defined and its Interaction with the Securities and Exchange Laws of Ghana(Part 3 of six)

Securities and Investment law

Bitcoin as a Security traded on the Securities and Exchanges Market Defined and its Interaction with the Securities and Exchange Laws of Ghana(Part 3 of six)

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It is clear that at this stage of the paper series I have been able to shoulder readers along to understand what bitcoin is all about in respect of its history, general concept, risk, investment and its volatility as well its uncertainty as an investment portfolio asset.

I will now seek to transpose readers into this new phase which touches on whether bitcoin is a security asset at all and if so can it be traded on the exchange market in Ghana.

Is Bitcoin A Security That Can Be Traded on the Ghana Securities and Exchange Market?

Cryptocurrencies including bitcoin around the world took a nosedive in early 2017. Immediately thereafter China announced a ban on Initial Coin Offerings (ICOs) for Chinese startups. The Chinese authorities indicated that this new form of fundraising mechanism has seriously disrupted the economic and financial order of the Country. This caused the price of bitcoin to plunge nearly 20% from its high of US$4,968 to a low of US$ 4,028 before rebounding to its recent price of US$ 4,654, Ian king 2017[1].

It is trite knowledge that technology goes beyond boundaries and jurisdiction, a fact which Ghana is not excluded from. In Ghana, the Securities and Exchange Commission (will be mostly referred herein as SEC) is established by the Securities Industry Act, 2016 (Act 929) with the object to regulate and promote growth and development of an efficient, fair and transparent securities market in which investors and the integrity of the market are protected.

The SEC has not yet come out with legal framework to regulate the already growing unregulated trading market of bitcoin or other virtual currencies in Ghana. At best the SEC has only warned and keeps warning the general public about the risk and illegality associated with the trading or investment in bitcoin. In fact, there really exist no statistics on its impact on the Ghanaian economy, whether positive or negative. The focus of this paper is to assess the need for legal compliance or regulation of the market and further look at how bitcoin trading by some persons could be breaching other existing laws of Ghana due to its unregulated nature.

As aforementioned, countries such as China and USA are leading with the regulation of the virtual currency market in the world. The trading of the virtual currency including bitcoin is across the internet. By this, there remain(remains) both registered and unregistered companies in Ghana operating bitcoin. The first thing to note is that a registered company under the laws of Ghana as a limited liability company is plausible but not exhaustive legally. Now, the company can operate to do business but where it seeks to trade in bitcoin trading raises a problem because the company is not licensed by SEC to do so and that puts the company in an illegal position because it is deemed to be trading in securities. I will discuss whether bitcoin is a security subsequently to further clarify this conclusion. Therefore a registered company that is unlicensed to trade in securities and yet trades in that acts illegally in Ghana. I will further argue why bitcoin is a security and why its trading needs to be licensed by SEC albeit regulations, so that companies trading can be licensed and be deemed legal.

On the other limb is a company not registered and definitely not licensed to trade in bitcoin but operates as a company and further has online presence. Further note that it is not even registered as a company under the Companies Act, 2019 Act 992. This second company be it as it may, unregistered, unincorporated and representing itself to third parties as a bitcoin trading company when its promoters know that they do not have the license to do so makes it fraudulent. This outrightly is sanctioned to be illegal. But what if the SEC regulates the industry and promulgates legislation and policy guidelines for these companies? Activities that are deemed to be illegal by virtue of operating cryptocurrency will be regularized except those involved in fraud and other forms of illegalities.

At this stage we need to satisfy our minds whether bitcoin is indeed a “security” and if so, it must be regulated.

My starting point to ascertain whether an investment or an asset can be called a security draws me to the celebrated American Supreme Court Case of Securities and Exchange Commission VRS J. Howey Company, 328 U.S 293 (1946) which promulgated the “Howey Test” to ascertain how and what elements can be set out to define an asset as a security is. This introduced the general applicability of security laws and I state:

An investment contract for the purpose of the securities Act means a contract, transact or scheme whereby a person invests his money in a common enterprise and is led to expect profit solely from the efforts of the promoter or a third party [excluded factors] it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interest in the enterprise’

The Howey test is clearly laid out into four main prongs. That is there must be ‘‘investment of money’’ by a person and this must be directed onto a “common enterprise” and that the person investing into this enterprise must have been “led to expect profit” and that this expectation must come from the “promoter” of the enterprise. Mind you the promoter here refers to the person who made the representations of the investment and not merely to mean a person who is now trying to incorporate a company. Some schools of thought hold the view that this test is of general application. 

Further to this point on the development of the under-reference test is another important American case of Tchercepnin VRS Knight, 389 U.S 332, 336 (1967) opined and affirmed that

In searching for the meaning and scope of the word security, form should be disregarded for substance and the emphasis should be on economic reality”.

I call this the revised test but the analysis of a security must be considered looking at the two tests. The substance option over form means that a person cannot peddle in securities trade even though their scheme does not strictly satisfy the Howey Test. By this revised test the nature of the scheme of investment is all that matters for the test. If the nature of the investment scheme satisfies the objective test that the scheme on the balance of probabilities evinces in the substance (natures of operation) security the form matters not.

This means that unscrupulous people who would want to out-smart the law per loop-holes would be caught. It means that one cannot say that the mere unregulated crypto industry in Ghana allows persons to create companies and trade in bitcoin as securities. My next point will be to argue how bitcoin is a security. In further analyzing whether bitcoin is a security I would discuss the point per the thematic areas below.

Given the knowledge of what a security is, it is proper to upscale the argument to whether bitcoin is a security or not. This would give readers a coherent understanding and follow the development of my argument.

Investment Money

According to Burgh 2016[2] of the Coin Centre in his assessment of the elements, certain features of the bitcoin we need to  look at are the main features or elements of the Howey test.

Distribution

Burgh 2016, indicates that just as the first point of the Howey test is about the question of investment, the test should serve as a guide for our consideration. In this light, one must consider the mode of distribution of new bitcoin through trading between users or investors and developers or wallet providers if this satisfies the first element in the test. It is important to note that trading by developers which is inevitably characterized by promises of future profits all fit and satisfies this first element of the test. By this, we could conclude that bitcoin is a security. Remember as I explained above, substance is what matters over form, because the law has expanded the scope of the catch-net definition. The next element in the Howey test to discuss is a common enterprise. 

Common Enterprise[3]

The law will now consider whether the investment is made in a common enterprise by users as they are informed by the owners or promoters to expect profits.

This area of law has significantly been developed by American securities law but on the contrary, the Ghanaian securities law and jurisprudence is not developed enough or has not been confronted with this problem for the Courts to make a pronouncement. It is trite law that foreign laws especially in the common wealth jurisdictions are persuasive to Ghanaian Laws[4].

Quickly discussing the lateral development of the law on securities per the Courts in the USA in this area indicates that a refine of the law on common enterprise as in the Howey test by the Circuit Courts of the U.S (High Courts in Ghana) is considered in two concepts; horizontal commonality and vertical commonality. This split is a necessity since it would help us to know which commonality satisfies the second test of Howey. The third, sixth and seventh circuits require horizontal commonality whiles the fifth, eighth, tenth and eleventh circuits use the vertical commonality. In short, there exist two schools of thought to establish common enterprise as an element in the Howey test. It is obvious that the Courts are divided on this legal position.

The Ghanaian Courts are yet to be confronted with this legal question as the securities and exchange market is now developing in Ghana let alone cryptocurrency trading. It is my utmost belief that where the Ghanaian Courts are confronted with this situation the mind of the court will be convicted to embrace either the horizontal or the vertical or may even develop.

What do these two concepts mean? Per the USA case of Hocking v Dubois[5], horizontal commonality was defined as the pooling of investors’ funds such that the fates of all investors rise or fall together, through a pro-rata sharing of profits. The Hocking case further went on to define vertical commonality as the sort where the fortunes of the investors are interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties. These definitions and concepts assist the court in concluding that a particular company is involved in securities especially given the substance or nature of the operation of the scheme albeit in cryptocurrency (bitcoin).

Expectation of Profits

Under this element in the Howey definition the lawyer is required to prove that there is an expectation of profit by the investors and that the expectation of profit has become a prime motivation for the investor to buy the bitcoin or any of the other virtual currencies. Where this is in the affirmative we can boldly say the trading in bitcoin is a security. In my next series I fully explain bitcoin as a security defined under the Ghana laws using these principles as explained to you.

Effects of a Third Party

In considering the final element per the definition of the Howey test, the lawyer or Court must establish that the bitcoin company (wallet providers or the promoter or advocate of the bitcoin or virtual currency) represented the common enterprise to the investor and he relied on it. Whether the common enterprise benefited the investor or caused his detriment is not the point but what is most important in law is that the investor can prove that he relied on the representations.

Definition of Security extending from common law to the Ghana Security laws

The development of the discussion concerning the definition of a security with regards to bitcoin investment and trading and other virtual currencies on the market leads us to typically consider the Ghanaian context vis-à-vis the Howey test and to assess whether the definitive elements in  Act 929 could cover bitcoin. If our analysis proves that bitcoin is a security then I would make recommendations to that effect to SEC and its related organs of State.

The definition of securities under section 216 of the Securities Industry Act[6] states that securities include:

  1. Shares or debentures within the meaning of the Companies Act,1963 ( Act 179);
  2. Loan instruments of a company
  3. Bonds or other loan instrument of the Government on the Government of any other country.
  4. Bonds or other loan instruments of a corporation established under an enactment.
  5. Rights or interest whether described as units or otherwise under any unit trust.
  6. Warehouse receipts
  7. Rightsor options in respect of any shares, debentures, bonds or notes.
  8. Commodities, futures, contracts, options or other derivations
  9. Derivatives as defined under this Act.

I have firmly demonstrated per my submission that bitcoin is a security. I will further proceed to narrow down my argument to what type of security instruments bitcoin could come under given its characteristics.

The first to consider under securities are “derivatives” under  Act 929. Per section 219 of the Act under reference, defines “derivatives” as a:

Financial instrument whose characteristics and value are dependent on or derived from one or more underlying assets[7], such as commodity, bonds, equity or currency”.

In further considering the definition of a derivative, Dan Robles (2015)[8] defines it as something whose value is derived from the value of something else. Derivatives have no intrinsic value in and of themselves. Their value is based on the expected future price movements of the underlying asset or benchmark. Dan Robles (2015) argues that bitcoin does not have intrinsic value in and of itself, rather the value of bitcoin is derived from the value of all that bitcoin can be used to do whereas it eliminates the gatekeepers of banking, insurance law and even governance. Kleinman 2018[9], quoting the Financial Times stated that a derivative is a security with a price that is dependent upon or derived from an underlying asset. He further pointed out that the derivative itself is a contract between the parties in respect of the asset. Therefore where the contract is tied to the asset its value would be determined by fluctuations in the underlying assets. Bitcoin can therefore be concluded to be a derivative under Act 929 based on the above-explained characteristics.

It is important to add that Elijah Bradley, 2019 further argued that derivative has evolved over the years to become a popular financial tool on the securities market. He added that it must be understood that it is a contract to transact a business and same is signed between two or more parties to buy or sell a particular asset at a determined price in the future[10]. The value of the contract is determined by changes or fluctuations in the price of the benchmark it derives its value from. I concur because, during the bitcoin trading, the Bitcoin Company or promoter makes representations of the common enterprise (scheme/investment/trading) to the investor and where he agrees to the profits thereon in the future an agreement is executed already. Now, the bitcoin derives its value from the underlying asset that the parties are seeking to trade in thereby qualifying bitcoin used in this sense as a derivative. 

Very important to note is that there are three types of derivatives namely futures, contracts and options. We shall look at all of these types in the light of bitcoin trade. But irrespective of the analysis readers need to understand that bitcoin trade comes under the broader financial tool of derivative and same is construed under the general term as a security.

From the foregoing, and the knowledge expounded so far, I will proceed to discuss another elementary feature of derivative which are “futures” and “options” which bitcoin trading is also characterized with. I would further consider these security instruments and interrogate whether bitcoin can come under them.

Section 216 of Act 929 defines futures as a:

“Contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future”

And further defined (defines) futures exchange as:

“…a central financial exchange where standardized future contracts can be traded”.

Further to these definitions, “Options” is defined that which gives the buyer the right, but not the obligation to buy or sell a certain asset at a specified price at any time during the life of the contract.

Buntix 2017, stated that bitcoin futures contract revolves around parties agreeing to buy or sell a specific amount of bitcoin or other cryptocurrencies at a pre-determined price on future date[11]. Thus, where the parties create a contract for future trading in bitcoin it comes under the definition of a “derivative” and the broader umbrella “security”. Now, this trading is transacted over a particular platform as provided by the contact. The platform is called the “future exchange” as defined above. It is now clear from my argument that bitcoin is deeply a security.

On the other hand Hanking 2017, opined that bitcoin traded as “Options” could further be traded in Options as “Call Options[12]” or “Put Options[13]”. I have to this point demonstrated how bitcoin features under the broad definitions of these financial instruments and in further consideration of the Howey test to firmly conclude that bitcoin is a “security”.  This conclusion leads me to my next discussion on whether bitcoin trading in Ghana infringes on any of our laws or if so what challenges does it pose to our financial laws and recommendations to SEC, lawyers and other relevant State institutions of interest.


[1] Ian King. Bitcoin Regulation: A necessary Evil. Article written on September, 2017.

[2] Peter Van Valkenburgh, Framework for Securities Regulation of Cryptocurrencies v1, Coin Center Report, Jan 2016, available at https://coincenter.org/2016/01/securities-framework/

[3] This means the investment scheme or the portfolio as proposed by the bitcoin company (seeking to trade)

[4] See Article 11 of the 1992 Constitution of the Republic of Ghana

[5] F 2d 560, 566 (9th Circuit 1988)

[6] Act 2016 ACT 929

[7] This means that it is a day trading which involves buying and selling an instrument with the aim at making profit.

[8]Dan Robles. Bitcoin is already a Derivative www.ingenesist.com/bitcoin-is-already-a-derivative/ retrieved on March 23, 2015.

[9] Bruce Kleinman. Bitcoin You are Holding Maybe a Derivative. https://hackernoon.com/bitcoin-you-are-holding-may-be-a-derivative-77bfalafdlb2 retrieved on March 23, 2015.

[10] Elijah Bradley. Derivative in Cryptocurrency Explained. https://cointelegraph.com/explained/derivatives-in-crypto-explained retrieved on March 12, 2020

[11] JP Buntix. What are Bitcoin Futures? http://themerkle.com/what-are-bitcoin-futures/ retrieved on June 2, 2017

[12] Call Option is an agreement that gives an investor the right and obligation to buy a stock, bond, commodity or other instruments at a specified price within a specific period when there is increase in price.

[13] Put Options is an option contract which gives the owner the right, but not obligation to sell to sell a specified amount of an underlying security at a specified price. The specified price is the put option buyer can sell is at the “strike price”.  

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