Initial Coin Offerings and What the SEC Might Think About Them: An Update

By Daniel Portnov
SEC HQ front.jpgEarlier this week I attended the DC Bar’s Communities program “Crypto Update: Current Issues Relating to Blockchain, Digital Assets and ICOs” featuring two members of the Commission’s staff – Assistant Director Jennifer Leete from the Enforcement

Division and the Deputy Chief Counsel Jonathan Ingram from the Division of Corporate Finance.[1] Like our post earlier this year from Commissioner Jackson’s reception, Ms. Leete and Mr. Ingram offered valuable insight into Enforcement and CorpFin’s thinking on cryptocurrencies and ICOs. (Necessary disclaimer: the views of the individual staff members did not reflect those of the Commission or their colleagues.)

The key takeaways from the program included:

  • Nearly 18 months after the DAO Report concluding that U.S. Securities laws may apply to sales and trading of digital assets, cryptocurrencies are still a “new environment” for the Enforcement Division. The concepts involved are challenging, but enforcing the space is a priority for the staff. As a result, cooperation and self-reporting by issuers and exchanges will go a long way toward mitigation of penalties and possibly charging decisions.
  • When considering an action, Enforcement still wrestles with the threshold question: is this token/coin/asset a security under the Howey test[2] and, if so, what exemptions may apply?
  • One tactic by counsel in the ICO space has been to pose hypothetical questions to Enforcement staff as a precursor to self-reporting. Ms. Leete noted that this anonymous, hypothetical approach is appropriately “a place to start” in exploring possible cooperation.
  • Although “novel,” almost all cryptocurrency enforcement has involved misstatements, failure to register or “run of the mill” fraud. Many of the fraud investigations feature familiar facts. Ms. Leete noted CentraTech and Blockvest as “fun” examples of the latter. (for more details, we wrote about both here and here). CentraTech recently involved two settled Administrative Proceedings with celebrities Floyd “Crypto” Mayweather and DJ Khaled for touting CentraTech’s offerings without proper disclosures.
  • Leete believes the recent Southern District of California decision denying the SEC’s request for preliminary injunction against Blockvest and its founder was limited to the specific questions of fact in that case, and not a permanent dent in the Commission’s view that token offerings fall under the ambit of securities laws.
  • Neither Ms. Leete nor Mr. Ingram knew of any instance where a cryptocurrency had once been a security but, in current form, is no longer a security. This was in response to a question based on CorpFin Director William Hinman’s statement this past summer regarding Ethereum and Bitcoin, which he no longer considered to be securities.
  • Continuing on the subject of security classification and a potential response to the Commodity Futures Trading Commission (CFTC) guidance on cryptocurrencies, Mr. Ingram hopes that the Commission will issue “plain English” guidance in early 2019.
  • Leete suggested CorpFin’s Statement on Digital Asset Securities Issuance and Trading (November 16, 2018) as a resource for CorpFin’s view of ICOs and a compendium of key Enforcement actions to date.
  • Ingram noted that the recently launched FinHub – the Commission’s gateway for public engagement on all things FinTech, including blockchain and digital assets – is up and running and has received approximately 130 requests/queries through last week. Response time is roughly 3-4 business days and teams of attorneys among the several divisions of the SEC are involved in crafting each response.
  • Per Mr. Ingram, we are in a “crypto bear market” as the capital raising in the second half of 2018 has dropped considerably in comparison to the first half of the year as issuers and investors are hesitant to run afoul of both the SEC and CFTC’s registration and sales requirements.

Based on the turnout and questions at the panel, attorneys in capital markets, regulatory and enforcement areas are keen to understand the Commission’s thinking on ICOs to better serve their clients. We, too, remain intrigued and will continue to report back from these panels, as well as provide additional insights on key enforcement developments.

[1] There were three other private sector attorney panelists, each an expert in the fields of blockchain and cryptocurrency and interesting in their own right. But this is an enforcement-focused blog, so I’m going to skip over much of what they said.

[2] The Howey test comes from SEC v. W.J. Howey Co., 328 U.S. 293 (1946), where the Supreme Court set forth factors to determine whether a transaction is an investment contract, and therefore governed by the Securities Act of 1933 and the Securities Exchange Act of 1934. Those factors are:

  1. An investment of money.
    2. In a common enterprise.
    3. With an expectation of profits predominantly from the efforts of others.
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