Initial Coin Offerings have had a free run until now, raising millions of dollars in a matter of minutes thanks to a cryptocurrency frenzy. All that may change now, with the SEC concluding that ICO tokens may be securities and subject to federal securities laws.
It was found that the DAO (Decentralized Autonomous Organization) tokens which were issued in 2016 were securities.
There has been a spate of Initial Coin Offerings recently, which have managed to raise millions of dollars.
Some organizations have found ICOs to be a convenient method to raise money for development, by tapping a new set of investors and avoiding the hassles associated with the traditional venture capital route.
There are no disclosure norms to be followed and anybody can invest in ICOs. Most investors consider ICOs a speculative asset and their interest in ICOs stem primarily from the rapid appreciation in price of the issued tokens, rather than the strength of the underlying business model.
The ‘easy money’ associated with ICOs has resulted in many fly-by-night operators issuing tokens and resulted in regulators across the world examining the legality of such offerings.
The DAO Case
The SEC’s Enforcement Division had launched an investigation into whether the DAO and associated entities were subject to securities laws when they launched the sale of DAO tokens for Ether.
The investigation concluded the DAO token was indeed a security and the sale of these tokens were subject to federal securities laws.
Although the DAO was described as a crowdfunding contract, it did not meet the requirements of the Regulation Crowdfunding exemption, as it was not a registered broker-dealer/funding portal.
Stephanie Avakian, Co-Director of the SEC’s Enforcement Division 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."
No charges to be filed
The SEC has decided not to file charges in this particular case, but use it as an opportunity to caution the industry and participants about ICOs. Securities laws apply to all entities which issue securities, irrespective of whether the entity is a traditional company or decentralized organization.
It does not matter whether the securities are purchased using fiat currency or using virtual currencies. The SEC has issued an investor bulletin, highlighting the risks associated with ICOs to investors.
Crucial question – security or not?
While the SEC has unequivocally concluded that the DAO tokens were indeed securities, not all ICOs have been brought under securities laws. It has stated that the facts and circumstances of any investment transaction (including economic realities) will determine whether the transaction constitutes the offer of sale of a security.
Token issuers may now have to turn to lawyers to confirm that the token that they intend to issue does not qualify as a security under federal securities laws.
If it indeed qualifies as a security, then the compliance costs associated with the offering may outweigh the benefits of raising money through an ICO.