Time To Kik SAFTS To The Curbbr>
On June 4, 2019, the U.S. Securities and Exchange Commission (“SEC”) launched an enforcement action against Kik Interactive claiming the company offered and sold one trillion digital tokens (“Kin”) in violation of the Securities Act of 1933 (the “Securities Act”).
The Securities Act requires an issuer of securities to either register the offering with the SEC or to conduct the offering pursuant to an exemption from registration. The SEC claims Kin are a security as defined in the Securities Act and that Kik failed to sell the securities pursuant to a registration or an exemption from registration under the Securities Act.
The case provides a valuable window into the SEC’s view of an instrument that has been widely used to raise funds in the digital asset space – the simple agreement for future tokens (“SAFT”).
What Are SAFTs?
A key component of the Kik token offering was the use of SAFTs. A SAFT is a combination of tokens offered through an initial coin offering (“ICOs”) and Simple Agreements for Future Equity (“SAFE”) which the SEC has warned investors are neither simple” or “safe. An ICO is a fundraising event in which an entity offers participants a unique digital asset – often described as a “coin” or “token” – in exchange for consideration (most commonly bitcoin, ether, U.S. dollars, or other fiat currency).
The KIK SAFTs
From May to September 2017, Kik offered and sold tokens to professional investment funds and other select, wealthy investors using SAFTs. The SAFTs entitled purchasers to the future delivery of Kin that they purchased when they entered into the agreements. Under the SAFTs, investors bought Kin at a discount to the price that the general public would pay, and Kik promised to deliver the tokens pursuant to a schedule, half at the time that it delivered tokens to the general public and half on the one-year anniversary of the first delivery. Kik received a total of approximately $100 million as a result of its offering and related sales of the SAFTs and Kin.
The Problem With SAFTs
Although Kik specifically stated the SAFT was a security, it did not advise purchasers that the Kin to be delivered under the SAFT were also securities. Kik’s private placement memorandum claimed the offer and sale of the SAFTs were effected in accordance with an exemption from registration under Section 4(a)(2) of the Securities Act and Regulation D. Kik did not claim any exemption for the offer and sale of Kin through the SAFTs.
Kik filed a Form D for the SAFTs indicating that it had sold securities. Under “Type(s) of Securities Offered,” the Form D stated: “Sale and issuance of rights to receive Kin tokens in the future via a Simple Agreement for Future Tokens.” Kik’s Form D claimed that the offering was exempt from the requirement to be registered under the federal securities laws, pursuant to the exemption for sales to accredited investors under SEC Rule 506(c).
The SEC believes that Kin offered and sold via the SAFTs was not exempt from registration under Regulation D. The SEC alleges “the exemption does not apply because the offer and sale of Kin via Kik’s SAFTs was part of a single offering of Kin to the general public . . . , or, in the alternative, was integrated with the offering of Kin whose sales began on September 12, 2017, and neither the totality of the offering nor the non-SAFT portion of it was limited to accredited investors.”
At the time of the publication of the SAFT whitepaper, leading members of the FinTech Bar questioned the soundness of the SAFT model. One member of the same group has described the SAFT as a Frankenstein financial product that combines the worst attributes of the SAFE which the SEC deems unsafe, with issuances of digital tokens which the SEC generally believes often involve an illegal offer and sale of securities without a registration. Hopefully, the Kik enforcement action will bring an end to the use of this ill-conceived financial product that is highly likely to expose the issuer of the SAFT (and the digital token issued upon conversion of a SAFT) to a potential SEC investigation and possible SEC enforcement action.
Richard Levin is chair of the Financial Technology & Regulatory Practice at Am Law 100 firm. Polsinelli.