While 10 years ago crypto currency seemed like a long shot to sustain itself for many, it is here to stay. That means it is important to learn the rules of the game and to see what types of issues to look out for. One area of particular interest is the Initial Coin Offering (or ICO) that businesses have used to raise funding. You will notice that the term ICO mimics the highly regulated Initial Public Offering (IPO) that is used when businesses issue shares to the general public.
SEC Involvement in ICO’s: The SEC has its sights set on these ICO’s and has said as early as 2017 that “by and large, the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws.” See SEC Statement on Cryptocurrencies and Initial Coin Offerings here.
What does securities registration mean: The SEC requires certain things from companies who intend to offer investment opportunities to the public. Registration is not just a one-time event, but also an ongoing obligation. The initial registration does require 1) a description of the company’s properties and business, 2) a description of the security to be offered for sale, 3) information about the management of the company, and 4) financial statements certified by independent accountants. While those steps seem easy enough, they require an immense amount of time and resources. For additional basic information about registering securities, you can go to the SEC information provided here.
Recent Court Case filed by SEC against an ICO: A recent case was filed by the SEC in the Northern District of California against an individual, Craig Sproule, and his two companies called Crowd Machine and Metavine over their “unregistered initial coin offering” of Crowd Machine Compute Tokens (CMCT’s) that took place from January to April 2018. The particular issue, in this case, is that the SEC claims that Sproule mislead investors claiming that the money was going to be used for app-development software on a decentralized network, but instead used $5.8 million to mine gold in South Africa without alerting investors. They also pursued claims that Sproule should have registered his ICO as it was the offering of securities.
While the defendants did not admit guilt here, they have consented to judgments that would bar them from future violation or participation in future securities offerings and would require them to permanently disable and seek delisting of the CMCT token. Additionally, Sproule cannot serve as a director or officer of the companies and must pay a six-figure fine.
Key Takeaways for Businesses: While the crypto space is not fully regulated and may not be for a short period longer, the SEC has shown a desire to be very aggressive in this space. While this doesn’t mean the SEC will always win in Court, sometimes just going to Court and fighting the SEC is a losing proposition due to the time and financial output required (which you cannot recover from the government by the way).
It should also be noted that the old saying “bad facts make bad law” holds true here as well. When an individual or business diverts funds that they receive from others (i.e. investors) then that individual or company is going to have an uphill battle when facing litigation by the SEC, or other regulatory bodies.
An example of an actually registered security where this took place was played out in the recent Theranos and Elizabeth Holmes lawsuit where the jury found Holmes guilty of investor fraud. See more information about that here.
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