What Does the SEC Say About Token Offerings?

The Securities and Exchange Commission (SEC) has been consistent in its regular messaging to the public on coin and token offerings.

The SEC Chairman, Jay Clayton, provided testimony to the Committee on Banking, Housing, and Urban Affairs of the United States Senate on February 6, 2018. On December 11, 2017, Chairman Clayton issued a statement targeted to “main street” investors and market professionals, and throughout 2017 the SEC issued press releases, statements, investor alerts, investor bulletins, and reports on investigations – all related to the cryptocurrency market and blockchain technology.

The SEC messaging is clear on several points:

  • The SEC is focused on the three aspects of its mission: to protect investors, to maintain fair, orderly and efficient markets, and to facilitate capital formation.
  • The SEC believes that most, if not all, token and coin offerings are securities offerings.
  • The current offering practices for coins and tokens are not compliant with securities laws.
  • The SEC will pursue and enforce the available protections for the benefit of retail or “main street” investors.

A few new highlights from Chairman Clayton’s testimony provide further insight into the current focus and direction of the SEC.

  1. Education for retail investors is necessary to provide tools for identifying and avoiding fraud.
  2. Coin or token offerings will be met with increased scrutiny and tighter application of the existing regulations to protect the public.
  3. Business entities merely changing a name to imply a connection to blockchain that does not reflect the underlying business are at risk of review.
  4. Blockchain technology is here to stay, and the SEC is optimistic about its ability to facilitate the markets and investor protection.

Chairman Clayton’s December statement was focused on legal aspects:

  • Whether a transaction involves a security does not turn on labelling but requires an assessment of the economic realities underlying the transaction.
  • How a token or coin is marketed can make a difference (see further discussion below).
  • The “simple agreement for future tokens” or SAFT framework is not the same as an exemption from regulation.
  • Market professionals like lawyers, accountants, and consultants need to focus on professional responsibilities in assessing transactions.

On December 11, 2017, the SEC also issued cease-and-desist proceedings with respect to Munchee Inc. and its initial coin offering.

The SEC was clear that the efforts of Munchee Inc. on social media touting the token and endorsing claims that there would be dramatic gains in the value of the tokens, or on initial coin offerings in general, were factors in determining the token could be a security.

Other specifically named factors were:

  • promoting a secondary market for the tokens,
  • (ii) not soliciting stakeholders in the existing Munchee application, and
  • (iii) emphasizing the importance of the continued work of the founders.

This was the SEC’s first statement on how the mechanics of making a token offering or an ICO will be considered when applying the test from the SEC v. W. J. Howey Co. The SEC has also halted trading of some issuers (UBI Blockchain, The Crypto Company), and is pursuing one in court for fraudulent, unregistered offerings of securities (Arisebank).

Industry professionals have responded to the SEC’s communications with gloomy forecasts for the fledging industry, citing increased regulation of the past few months, and increased caution to promoters and startup groups considering token offerings.

Based on Chairman Clayton’s testimony, we anticipate that 2018 will see the SEC active in the protection of retail investors, and aggressive in pursuit of fraudulent actors.

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Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.