Cryptocurrency & Initial Coin Offerings – SEC Chairman’s Statement

Cryptocurrency & Initial Coin Offerings – SEC Chairman’s “Statement on Cryptocurrencies and Initial Coin Offerings”

On December 11, 2017, SEC Chairman Jay Clayton issued a “Statement on Cryptocurrencies and Initial Coin Offerings.” The statement provided the SEC Chairman’s general views on the cryptocurrency and ICO markets and, among other things, important considerations for “Main Street” investors involved with cryptocurrency- and ICO-related investments.**

Select Highlights of the SEC Chairman’s Statement Regarding Cryptocurrency and Initial Coin Offerings

The cryptocurrency and Initial Coin Offering markets have grown rapidly.  The cryptocurrency and Initial Coin Offering markets are local, national and international and include an ever-broadening range of products and participants.  The cryptocurrency and ICO markets also present investors and other market participants with many questions, such as:

• Is the product legal?
• Is it subject to regulation, including rules designed to protect investors?
• Does the product comply with those rules?
• Is the offering legal?
• Are those offering the product licensed to do so?
• Are the trading markets fair?
• Can prices on those markets be manipulated?
• Can I sell when I want to?
• Are there substantial risks of theft or loss, including from hacking?

Cryptocurrency & Initial Coin Offerings – Considerations for “Main Street” Investors

A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.  

Investors should understand that, to date, no initial coin offerings have been registered with the SEC.  The SEC also has not, to date, approved for listing and trading any exchange-traded products (e.g., ETFs) holding cryptocurrencies or other assets related to cryptocurrencies. If any person today tells you otherwise, be especially wary. 

The CFTC has designated bitcoin as a commodity.  Fraud and manipulation involving bitcoin traded in interstate commerce are appropriately within the purview of the CFTC, as is the regulation of commodity futures tied directly to bitcoin.  That said, products linked to the value of underlying digital assets, including bitcoin and other cryptocurrencies, may be structured as securities products subject to registration under the Securities Act of 1933 or the Investment Company Act of 1940. 

Cryptocurrency & Initial Coin Offerings- Investors: Ask Questions & Get Clear Answers!!

Questions for Investors Considering Cryptocurrency or ICO Investments

• Who exactly am I contracting with?
• Who is issuing and sponsoring the product, what are their backgrounds, and have they provided a full and complete description of the product?  Do they have a clear written business plan that I understand?
• Who is promoting or marketing the product, what are their backgrounds, and are they licensed to sell the product?  Have they been paid to promote the product?
• Where is the enterprise located?
• Where is my money going and what will be it be used for?  Is my money going to be used to “cash out” others?
• What specific rights come with my investment?
• Are there financial statements?  If so, are they audited, and by whom?
• Is there trading data?  If so, is there some way to verify it?
• How, when, and at what cost can I sell my investment?  For example, do I have a right to give the token or coin back to the company or to receive a refund?  Can I resell the coin or token, and if so, are there any limitations on my ability to resell?
• If a digital wallet is involved, what happens if I lose the key?  Will I still have access to my investment?
• If a blockchain is used, is the blockchain open and public?  Has the code been published, and has there been an independent cybersecurity audit?
• Has the offering been structured to comply with the securities laws and, if not, what implications will that have for the stability of the enterprise and the value of my investment?
• What legal protections may or may not be available in the event of fraud, a hack, malware, or a downturn in business prospects?  Who will be responsible for refunding my investment if something goes wrong?
• If I do have legal rights, can I effectively enforce them and will there be adequate funds to compensate me if my rights are violated?

As with any other type of potential investment, if a promoter guarantees returns, if an opportunity sounds too good to be true, or if you are pressured to act quickly, please exercise extreme caution and be aware of the risk that your investment may be lost.

Cryptocurrency & Initial Coin Offerings – Cryptocurrencies, ICOs & Securities Registration

Cryptocurrencies. Cryptocurrencies purport to be items of inherent value (similar, for instance, to cash or gold) that are designed to enable purchases, sales and other financial transactions.  They are intended to provide many of the same functions as long-established currencies such as the U.S. dollar, euro or Japanese yen, but do not have the backing of a government or other body.

Although the design and maintenance of cryptocurrencies differ, proponents of cryptocurrencies highlight various potential benefits and features of them, including (1) the ability to make transfers without an intermediary and without geographic limitation, (2) finality of settlement, (3) lower transaction costs compared to other forms of payment and (4) the ability to publicly verify transactions.  Other often-touted features of cryptocurrencies include personal anonymity and the absence of government regulation or oversight.  Critics of cryptocurrencies note that these features may facilitate illicit trading and financial transactions, and that some of the purported beneficial features may not prove to be available in practice.

It has been asserted that cryptocurrencies are not securities and that the offer and sale of cryptocurrencies are beyond the SEC’s jurisdiction.  Whether that assertion proves correct with respect to any digital asset that is labeled as a cryptocurrency will depend on the characteristics and use of that particular asset.

Initial Coin Offerings. Coinciding with the substantial growth in cryptocurrencies, companies and individuals increasingly have been using initial coin offerings to raise capital for their businesses and projects.  Typically, these offerings involve the opportunity for individual investors to exchange currency such as U.S. dollars or cryptocurrencies in return for a digital asset labeled as a coin or token.

These offerings can take many different forms, and the rights and interests a coin is purported to provide the holder can vary widely.  A key question for all ICO market participants: “Is the coin or token a security?”  As securities law practitioners know well, the answer depends on the facts.  For example, a token that represents a participation interest in a book-of-the-month club may not implicate our securities laws, and may well be an efficient way for the club’s operators to fund the future acquisition of books and facilitate the distribution of those books to token holders.  In contrast, many token offerings appear to have gone beyond this construct and are more analogous to interests in a yet-to-be-built publishing house with the authors, books and distribution networks all to come.  It is especially troubling when the promoters of these offerings emphasize the secondary market trading potential of these tokens.  Prospective purchasers are being sold on the potential for tokens to increase in value – with the ability to lock in those increases by reselling the tokens on a secondary market – or to otherwise profit from the tokens based on the efforts of others.  These are key hallmarks of a security and a securities offering.

By and large, the structures of initial coin offerings that the SEC Chairman has seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of the U.S. federal securities laws.  Generally speaking, these laws provide that investors deserve to know what they are investing in and the relevant risks involved.

It is possible to conduct an ICO without triggering the SEC’s registration requirements.  For example, just as with a Regulation D exempt offering to raise capital for the manufacturing of a physical product, an initial coin offering that is a security can be structured so that it qualifies for an applicable exemption from the registration requirements.

Cryptocurrency & Initial Coin Offerings – SEC-Related Alerts, Bulletins & Statements

The SEC has issued the following investor alerts, bulletins, and statements on initial coin offerings and cryptocurrency-related investments, including those related to the marketing of certain offerings and investments by celebrities and others:

Statement on Potentially Unlawful Promotion of Initial Coin Offerings and Other Investments by Celebrities and Others (Nov. 1, 2017), available at https://www.sec.gov/news/public-statement/statement-potentially-unlawful-promotion-icos

Investor Alert: Public Companies Making ICO-Related Claims (Aug. 28, 2017), available at https://www.sec.gov/oiea/investor-alerts-and-bulletins/ia_icorelatedclaims

Investor Bulletin: Initial Coin Offerings (July 25, 2017), available athttps://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_coinofferings

Investor Alert: Bitcoin and Other Virtual Currency-Related Investments (May 7, 2014), available athttps://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-alert-bitcoin-other-virtual-currency

Investor Alert: Ponzi Schemes Using Virtual Currencies (July 23, 2013), available at https://www.sec.gov/investor/alerts/ia_virtualcurrencies.pdf.

See also Kehoe Law Firm’s “Initial Coin Offerings – Be Aware of Potential Initial Coin Offering Risks” posting providing information from the SEC’s Office of Investor Education and Advocacy.

Cryptocurrency & Initial Coin Offerings – SEC Enforcement Actions

Press Release, Company Halts ICO After SEC Raises Registration Concerns (Dec. 11, 2017), available at https://www.sec.gov/news/press-release/2017-227

Press Release, SEC Emergency Action Halts ICO Scam (Dec. 4, 2017), available at https://www.sec.gov/news/press-release/2017-219

Press Release, SEC Exposes Two Initial Coin Offerings Purportedly Backed by Real Estate and Diamonds (Sept. 29, 2017), available at https://www.sec.gov/news/press-release/2017-185-0.

**The SEC Chairman’s statement contained a footnote which stated that the information in the SEC Chairman’s statement is his own and does not reflect the views of any other Commissioner or the Commission.  Further, the SEC Chairman’s statement is not, and should not be taken as, a definitive discussion of applicable law, all the relevant risks with respect to these products, or a statement of the SEC Chairman’s position on any particular product.  Additionally, the SEC Chairman’s statement is not a comment on any particular submission, in the form of a proposed rule change or otherwise, pending before the SEC.

Source: “Statement on Cryptocurrencies and Initial Coin Offerings” (December 11, 2017) by SEC Chairman Jay Clayton, available at https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11#_ftn6 (last accessed 12.31.2017).

Cryptocurrency (“Bitcoin”) & Initial Coin Offering Investors

If you are an investor of cryptocurrency (e.g., Bitcoin) or Initial Coin Offerings and have concerns about your legal rights or potential legal claims and wish to speak privately with a securities attorney, please complete the form above on the right or e-mail [email protected].

Kehoe Law Firm, P.C.