The most recent actions by the Securities Exchange Commission (SEC) demonstrate that it is time for projects and companies to rethink those carefully worded conclusions that considered their ICO and digital asset trading activities to be outside of SEC regulation or enforcement actions. And even for entities that are just transacting with companies at risk, it is time to raise the bar on the due diligence scrutiny.
Two weeks ago (on 11/16/2018), the SEC released a Statement on Digital Asset Securities Issuance and Trading that briefly outlines the most recent enforcement activity in the space, as well as sets the tone for further actions to come. The statement focuses on the Commission’s Division of Corporation Finance actions involving AirFox, Paragon, Crypto Asset Management, TokenLot, and the well-publicized settlement of charges by the SEC against Zachary Coburn, founder of EtherDelta.
All of these actions focus primarily on the premise that the SEC considers (almost) all cryptocurrencies or tokens to be securities under the Federal Laws. This interpretation was first made public when the SEC issued the DAO Report (July 2017) and was later confirmed by the Munchee Order (Dec 2017).
Then in Feb 2018, Jay Clayton (SEC Chairman) declared at a United States Senate hearing: “I believe every ICO I’ve seen is a security”. A few months later, Willian Hinman (Director of SEC’s Division of Corporation Finance) also confirms the same interpretation in connection with ICOs and related activities.
The last public announcement from the SEC was made again by Jay Clayton just yesterday, during the Consensus: Invest conference in Manhattan, New York. Among other things, he stated: “If you finance a venture with a token offering, you should start with the assumption that it is a security.”.
There are still a number of open investigations and charges will continue to be issued. The SEC has been overemphasizing the concept of the functional approach (that takes into account the relevant facts and circumstances) when assessing whether (i) a digital asset is a security; (ii) a system constitutes an exchange; or (iii) an entity meets the definition of a broker or dealer, in all three cases regardless of how an entity may characterize either itself or the particular activities or technology used to provide the services.
With this functional approach, the SEC’s intended message is really: ‘if it quacks like a duck, come talk to us, or we will come talk to you soon enough’. Or, in the actual words of the SEC: “These two matters demonstrate that there is a path to compliance with the federal securities laws going forward, even where issuers have conducted an illegal unregistered offering of digital asset securities.”
Therefore, at this point, considering how things have evolved, if you are (already or about to get) involved in an ICO or related activity, or even in a transaction with a company involved in that space, you should really make sure that you or your counterpart are on the safe side of this discussion.
The good news: the regulated avenue is probably sufficiently wide for most projects, especially if one decides to use all possible lanes. With the simultaneous use of different exempted issuances (commonly referred to as Regulation D, Regulation A+, Regulation S, just to name a few), it is possible to safely raise considerable amounts of capital from a reasonably vast number of individuals. Yes, restrictions apply. But in the current days, it is becoming more and more clear that it is better to ask for permission than for forgiveness.
Finally, from what I have seen with a variety of projects, it seems that legal fees and regulatory burden are going to be significantly reduced if companies decide to walk hand in hand with the SEC.
Keep an open eye…