ICOs seeking to crowdfund their big idea have a quandary: should they register their token as a security, complete with the expense, delays, and paperwork this entails, or should they brand it a utility and hope the SEC doesn’t come after them? Last year, virtually everything was labeled a utility and SEC-compliant crowdsales were almost unheard of. But in 2018, launching a utility token in the U.S. is fraught with risks and uncertainty. To tap into the lucrative U.S. market, the regulatory route is now the only viable path to follow.
Ignorance of Securities Law Is No Excuse
When token sales emerged, they were seen by advocates as a great source of capital that circumvented existing restrictions on fundraising. As it turns out, ICOs can be a great means of raising money, but they are not a new fundraising vehicle that is exempt from the law. For the first half of 2017, ICOs such as Tezos merrily raised funds from U.S. investors under the assumption that their crowdsale was above board because it involved a utility token rather than a security. But as subsequent lawsuits have shown, just because something’s branded as a utility doesn’t make it one.
By late last year, the number of ICOs willing to accept U.S. investors had dwindled to a trickle and projects were tripping over themselves to preface every mention of their token with the words “UTILITY” for the avoidance of doubt. Others have published their responses to the Howey Test as further evidence that their token could not possibly be a security. Well-meaning as these attempts may be, they do not change the fact that most ICO tokens almost certainly constitute a security, a view espoused by SEC chairman Jay Clayton.
Litigation Lawyers Have Their Say
At Start Engine’s ICO 2.0 Summit in Santa Monica on April 20, one of the most interesting panel discussions was loaded with litigators. “ICO Litigation and Enforcement Update” included Nick Morgan, a partner at Paul Hastings, Dan Moylan, a litigator at Venable, and Perrie Weiner from DLA Piper, all of whom are familiar with the inner workings of the SEC and securities law.
Nick Morgan was senior trial counsel in the SEC’s enforcement division, making him well aware of the reluctance of the SEC to say “Yes”. “In 2017 we saw a lot of ‘No’,” he observed during the panel discussion. “The question is ‘Can I offer my token for sale without registering it or being exempt?’ The SEC in 2017 and 2018 has repeatedly said ‘No’…What we’re waiting for and hopeful to see…is a ‘Yes’ from the SEC.”
He later added: “The first place we may get a ‘Yes’ will be from a judge,” and explained how “institutionally [the SEC] are reluctant to do so, because once they say ‘Yes’, everyone goes through that channel…but we may see a judge, in a case that’s being litigated, who says ‘This is not a security’”.
Fellow panelist and litigator Dan Moylan noted: “When you look at the various regulatory agencies’ statements and actions in 2017 and so far in 2018, frankly in many ways they’re predictable…they told you what they were gonna do. They made it very clear, whether it’s the SEC or the CFTC or any number of other alphabet agencies.”
Darren Marble, CEO of Crowdfundx, who was also in attendance at the summit, and a participant in a later panel discussion, told news.Bitcoin.com:
Regulations are designed to protect investors. At the end of the day, investors have to win for blockchain businesses and cryptocurrencies to continue to thrive. With the recent spate of scams, fraud, and theft associated with ICOs, STOs [security token offerings] are a welcome, much needed alternative. While disclosure will never root out every scam deal, it will certainly reduce the number of bad actors and draw higher caliber issuers into the market.
Anything You Say Can and Will Be Used Against You
One of the take home messages from the Start Engine summit was that prior to embarking on a token sale and going public with their intent, entrepreneurs should talk to a lawyer. Any initial outlay this incurs is nothing compared to the sort of legal expenses that could be encountered further down the line should things go south and litigators come calling.
“Where do people get in trouble?” asked Dan Moylan. “What’s quoted in the complaint the SEC files or a plaintiff files? You see public statements. So…think long and hard and be very deliberate about the public statements you make. You know public companies, for example, pore over their public statements and SEC filings and investor calls…because they know that after the fact some plaintiff’s lawyer or a regulator…with the full benefit of 20/20 hindsight is gonna see if something might not be true or might be misleading.”
He encouraged anyone considering launching an ICO to be “very thoughtful” about its structure and about “what you say in connection with it”. In one of the lawsuits filed against Tezos, for example the complaint highlights a Reddit AMA that Kathleen Breitman performed in which she referred to herself as a “one-woman band”, a seemingly innocuous statement, which which was later taken to suggest the extent to which she was responsible for what happened with Tezos.
Dan Moylan observed: “The SEC made a show of going after the bad actors to shock the industry, to make it clear this is not an avenue that won’t be regulated in cases of fraud.” But as Perrie Weiner of DLA Piper noted, just because regulators are watching the space closely shouldn’t be cause for fear. He explained that the SEC don’t want to shut down the entire industry, but simply want “to ferret out the bad apples from the good”.
Crowdfundx’s Darren Marble concluded: “The good news is that US-based blockchain companies have several available options for running a compliant security token offering (STO). Reg D is fast, easy, and efficient, has no cap on the raise, and allows verified accredited investors to invest. Reg A+ allows anyone over 18 globally to invest, has a $ 50 million cap on the raise, requires audited financials and filing a Form 1-A with the SEC.”
In the security tokens era, ICOs pleading ignorance have no place to hide. Following the regulatory route may seem arduous, but it’s the only course of action that will allow U.S.-based startups to sleep easy. Given the large sums at stake, the costs of compliance are a drop in the bucket in comparison. Thanks to the added confidence such regulatory approval will give to investors, ICOs may conclude that it’s money well spent.
Do you think full SEC compliance is the only way to safely launch a token sale in the U.S.? Let us know in the comments section below.
Images courtesy of Shutterstock and Start Engine.
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