SEC Warns That Coin/Token Offerings are Securitiesbr>
In what portends to be a major change for the blockchain industry, the US Securities and Exchange Commission (SEC) said today that initial coin offerings or token sales are subject to the requirements of federal securities laws.
Many blockchain startups have bypassed the traditional venture capital and private equity paths to raise funds via initial coin offerings, wherein tokens offering value within the startup ecosystem are exchanged for cryptocurrency.
However, the SEC’s investigative report released today concluded that no matter the terminology or technology used, whether a particular investment transaction involves the offer or sale of a security will depend on the “economic realities of the situation.” In other words, raising money in exchange for a promissory token is the same as a security.
The SEC’s Report of Investigation used an historical example to make its point. They found that tokens offered and sold by a virtual organization known as The DAO were, in fact, securities, and therefore subject to the federal securities laws. The DAO, envisioned as a decentralized investor capital fund, was crowdfunded via a token sale in May, 2016. It set the record for the largest crowdfunding campaign in history at the time. The DAO was eventually hacked and delisted on several exchanges.
In its key warning, the SEC said issuers of blockchain securities must register offers and sales of such securities. Those participating in unregistered offerings “may be liable for violations of the securities laws. It added that exchanges providing for trading in those securities must register with the SEC unless exempt.
“The purpose of the registration provisions of the federal securities laws is to ensure that investors are sold investments that include all the proper disclosures and are subject to regulatory scrutiny for investors’ protection,” said an SEC statement.
“The SEC is studying the effects of distributed ledger and other innovative technologies and encourages market participants to engage with us,” said SEC Chairman Jay Clayton. “We seek to foster innovative and beneficial ways to raise capital, while ensuring – first and foremost – that investors and our markets are protected.”
“Investors need the essential facts behind any investment opportunity so they can make fully informed decisions, and today’s Report confirms that sponsors of offerings conducted through the use of distributed ledger or blockchain technology must comply with the securities laws,” said William Hinman, Director of the Division of Corporation Finance.
The SEC’s Report stems from an inquiry that the agency’s Enforcement Division launched into whether The DAO and associated entities and individuals violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for ether. The SEC claimed The DAO was described as a “crowdfunding contract,” but it would not have met the requirements of the Regulation Crowdfunding exemption because, among other things, it was not a broker-dealer or a funding portal registered with the SEC and the Financial Industry Regulatory Authority, the agency said.
“The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division.
Steven Peikin, Co-Director of the Enforcement Division added, “As the evolution of technology continues to influence how businesses operate and raise capital, market participants must remain cognizant of the application of the federal securities laws.”
The SEC said it would not bring charges against those involved in the DAO or find other violations. But they warned that “federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology.”
The SEC’s Office of Investor Education and Advocacy today issued an investor bulletin educating investors about ICOs. As discussed in the Report, virtual coins or tokens may be securities and subject to the federal securities laws. The federal securities laws provide disclosure requirements and other important protections of which investors should be aware. In addition, the bulletin reminds investors of red flags of investment fraud, and that new technologies may be used to perpetrate investment schemes that may not comply with the federal securities laws.