ICOs

Settlements of SEC Registration Charges with Two ICO Issuers Serve as Warning and Compliance Models

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On November 16, the Securities Exchange Commission (“SEC“) announced settled charges against two companies that sold digital tokens in initial coin offerings (“ICOs“). According to the Press Release announcing these settlements, these are the Commission’s first cases imposing civil penalties solely for ICO securities offering registration violations. The remedies agreed to include the return of funds to harmed investors, the registration of the tokens as securities under the Securities Exchange Act of 1934, the filing of periodic reports with the Commission, and the payment of $ 250,000 as a monetary penalty. READ MORE →

SEC Charges EtherDelta Founder with Operating an Unregistered Securities Exchange

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On November 8, the Securities and Exchange Commission (“SEC“) announced that it has settled charges against Zachary Coburn, the founder of EtherDelta, a digital token trading platform. Significantly, this is the SEC’s first enforcement action based on findings that such a platform operated as an unregistered national securities exchange. The SEC has previously brought enforcement actions relating to unregistered broker-dealers and unregistered Initial Coin Offerings (“ICOs“), including some of the tokens traded on EtherDelta.

According to the SEC’s order, EtherDelta is an online platform for secondary market trading of ERC20 tokens, a type of blockchain-based token commonly issued in ICOs. The order found that Coburn caused EtherDelta to operate as an unregistered national securities exchange.

As stated in the Press Release and Order, EtherDelta provided a marketplace for bringing together buyers and sellers for digital asset securities through the combined use of an order book, a website that displayed orders, and a “smart contract” run on the Ethereum blockchain. Most notably, over an 18-month period, EtherDelta’s users executed more than 3.6 million orders for ERC20 tokens, including tokens that are securities under the federal securities law. Notably, the SEC did not identify the specific tokens it found to be securities or the salient characteristics thereof.

Therefore, EtherDelta acted as an online national securities exchange and was required to register with the SEC or qualify for an exemption.

The SEC’s investigation is ongoing.

FINRA’s 2018 Regulatory and Examination Priorities Letter Includes Initial Coin Offerings and Cryptocurrencies

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On January 8, 2018, the Financial Markets Regulatory Authority (“FINRA“) published its 2018 Regulatory and Examination Priorities Letter which identifies topics that FINRA will focus on in the coming year.

Included for the first time are Initial Coin Offerings and Cryptocurrencies. Specifically, the Priorities Letter states: “Digital assets (such as cryptocurrencies) and initial coin offerings (“ICOs“) have received significant media, public and regulatory attention in the past year. FINRA will closely monitor developments in this area, including the role firms and registered representatives may play in effecting transactions in such assets and ICOs. Where such assets are securities or where an ICO involves the offer and sale of securities, FINRA may review the mechanisms—for example, supervisory, compliance and operational infrastructure— firms have put in place to ensure compliance with relevant federal securities laws and regulations and FINRA rules.”

The full letter is available here

SEC Chairman Statement on Cryptocurrencies and Initial Coin Offerings

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On December 11, SEC Chairman Jay Clayton issued his own statement (“Statement”) concerning cryptocurrencies and “initial coin offerings”  (“ICOs”).  The Statement provides a thorough review of the primary securities regulatory issues and urges caution on the part of issuers and market participants. To view the full statement, click here.

ESMA Statements on ICO Risks for Firms and Investors

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Following the European Securities and Markets Authority‘s (“ESMA“) observation in rapid-growth initial coin offerings (“ICOs“)s, on November 13, 2017, ESMA issued two statements on ICOs.

ESMA notes in a statement for firms that where ICOs qualify as financial instruments, it is likely that the firms involved in ICOs will be conducting regulated investment activities, whereby they need to comply with the relevant legislation, including:

  • Markets in Financial Instruments Directive (2004/39/EC) (“MiFID“). Where the coin or token qualifies as a financial instrument, the process by which a coin or token is created, distributed or traded is likely to involve some MiFID activities and services, such as placing, dealing in or advising on financial instruments.
  • Alternative Investment Fund Managers Directive (2011/61/EU) (“AIFMD“). An ICO scheme could qualify as an alternative investment fund (“AIF“), to the extent that it is used to raise capital from a number of investors, with a view to investing it in accordance with a defined investment policy.
  • Prospectus Directive (2003/71/EC) requires publication of a prospectus before the offer of transferable securities to the public or the admission to trading of such securities on a regulated market situated or operating within a member state. Also, the Prospectus Directive specifies that the prospectus should contain the necessary information that is material to an investor for making an informed assessment of the facts and that the information shall be presented in an easily analyzable and comprehensible form.
  • Fourth Money Laundering Directive ((EU) 2015/849) (“MLD4“).

ESMA stresses that any failure by firms to comply with the applicable rules will constitute a breach. Firms involved in ICOs must give due consideration as to whether their activities constitute regulated activities.

A statement for investors by ESMA also alerts them of the high risk of losing all of their invested capital as ICOs are highly speculative investments. ICOs are vulnerable to the risk of fraud or money laundering.

Depending on how they are structured, ICOs may fall outside of the scope of EU law and regulations, in which case investors cannot benefit from the protection that these laws and regulations provide. Also, the price of the coin or token is typically extremely volatile, and investors may not be able to redeem them for a prolonged period.