Crow & Cushing Commentary: The SEC And Intial Coin Offerings

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A new commentary by Crow & Cushing, The SEC and the ICO, examines the current state of SEC regulations around investing in cryptocurrencies.  An increasingly common use of these currencies is the initial coin offering, or ICO.  Companies are using ICOs to raise funds by offering investors a chance to buy into a new venture using a cryptocurrency in exchange for virtual tokens instead of stock in the company. The tokens grant investors access to a product or service to be offered by the token issuer.  Sound confusing?  It is.

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The Crow & Cushing commentary provides eye-opening facts and insights into ICOs and the SEC response to them.  Here are some key takeaways:

The SEC has taken a measured approach in warning potential ICO sponsors and online platforms that support trading of tokens that they might be subjected to US securities laws.  One particular case got the SEC’s attention:

  • The SEC picked on an ICO which its sponsor called The DAO, for Decentralized Autonomous Organization, which is a term used to describe a “virtual” organization embodied in computer code and executed on a distributed ledger or block chain.
  • The DOA’s website explained its intended purpose online via a “White Paper” in this way: “To blaze a new path in business for the betterment of its members, existing simultaneously nowhere and everywhere and operating solely with the steadfast iron will of unstoppable code.”
  • The token issue sold out.  However, before the DOA could commence funding, an attacker exploited a flaw in its code and stole approximately one-third of the assets.

The SEC undertook an investigation to determine whether the tokens were securities necessitating registration.  The investigation concluded that the tokens were securities, since they qualified as an “investment contract” under the securities laws, a term that is broad enough to include an offer, like the one it examined, which involves a decentralized autonomous organization, a cryptocurrency or a block chain-enabled means for raising capital, or a scheme involving all three.

The only serious question for the SEC was whether the rights of token holders to vote on projects the coin issuer would undertake made them more than passive participants in the enterprise.  Due to limited voting rights and the wide distribution of the tokens, it was determined that owners’ contribution to the management of the DOA was insignificant.

In the long run, while the SEC declined to pursue an enforcement action, its messages to the market were clear:

  • There is more to soliciting investments in a common venture than circulating  a “White Paper” and mission statement online
  • The SEC will in the future ensure that potential investors in ICOs are afforded the procedural protections and the disclosure of material information that comes with registration under the securities laws.

Whether this works to reduce the possibility of ICO scams or to cool the ardor of investors for these schemes remains to be seen.

For further analysis and opinion, review the paper here:

Crow & Cushing is a law firm in Princeton, NJ, specializing in serving the alternative investment industry.

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