SEC: No Really, ICOs Are Securities
Posted on 01/11/2019 at 12:42 PM by John Lande
A common trope is that technology is evolving too fast for the law to keep up. Companies like Uber, Tesla, and Coinbase race forward while ignoring whether their technologies or activities are covered by any existing regulatory framework.
Many of these companies have had a rude awakening. A list of Uber’s legal disputes reads like a bucket list of state and international jurisdictions to visit. Tesla’s head landed in hot water with the SEC after he tweeted that he had funding secured to take Tesla private. And last year, this blog covered the news that Coinbase had to turn over thousands of records of cryptocurrency transactions to the IRS.
In a trio of recent enforcement actions, the SEC further cemented its position that cryptocurrencies that look and act like securities are governed by existing securities laws. This is not news to anyone who has been following SEC and Department of Justice (“DOJ”) litigation. For example, last year this blog covered DOJ charges against an ICO promoter for securities fraud.
The SEC rulings apply securities laws to nearly every phase of initial coin offerings (“ICOs”). The first SEC ruling involved the creator of the EtherDelta website. EtherDelta was a coin trading website that, according to the SEC, “resembles online securities trading platforms.” The SEC issued a report on July 27, 2017, that concluded any cryptocurrency platform that allows trading of cryptocurrencies meeting the definition of “security” has to register as an exchange under federal securities laws. In one year, EtherDelta processed over 3.6 million cryptocurrency buy and sell orders, 92% of which occurred after the SEC’s July 27, 2017 report. Since the SEC has generally found cryptocurrencies are securities, EtherDelta should have registered as an exchange. Due to its failure to register, EtherDelta and its creator had to pay almost $400,000 to the SEC in fines and interest charges, and cease and desist from violating federal securities laws.
The second SEC ruling involved Paragon Coin. According to its own materials, Paragon claimed it would “pull the cannabis community from marginalized to mainstream by building blockchain into every step of the cannabis industry . . . .” Paragon represented that the “lion’s share” of the proceeds from the sale of coins would be spent on real estate for Paragon co-working spaces for cannabis related businesses. Paragon represented that it would use money raised from the ICO to build an ecosystem where Paragon coins could be used to make purchases. Paragon raised approximately $12 million through its ICO.
Based on Paragon’s representations, the SEC concluded that Paragon’s ICO involved the offer and sale of securities. As a result, Paragon had to comply with federal securities laws, which require preparation and filing of registration statements, among other requirements. The SEC ordered Paragon to allow investors to submit claims for reimbursement and to otherwise comply with federal securities laws.
The third SEC ruling involved Floyd Mayweather Jr.’s promotion of three ICOs. Mayweather had over 21 million Instagram followers, 13 million Facebook followers, and 7 million Twitter followers. Mayweather received $300,000 in total from three ICO operators to promote their ICOs with posts such as: “You can call me Floyd Crypto Mayweather from now on . . . .” The SEC ruled that Mayweather violated federal securities laws by failing to disclose that he was receiving compensation from the ICOs that he promoted. Mayweather was ordered to pay to the SEC $300,000 plus interest plus a penalty of $300,000, and refrain for three years from promoting any other ICOs.
There is no doubt that blockchain technology has the potential to revolutionize all kinds of industries. However, just because a technology is new does not mean that existing laws and regulations do not apply. Entrepreneurs of all kinds would be well advised to discuss new opportunities with experienced legal counsel to determine if their cutting edge technology or ideas run afoul of any existing law.
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