December 20, 2017

ICOs: This is What a Warning Shot Looks Like

Last week, SEC Chair Jay Clayton issued another cautionary statement on cryptocurrencies & ICOs. The statement covers a lot of ground – and it zeroes in on the professionals involved in these deals & their actions following the SEC’s 21(a) Report:

Following the issuance of the 21(a) Report, certain market professionals have attempted to highlight utility characteristics of their proposed initial coin offerings in an effort to claim that their proposed tokens or coins are not securities. Many of these assertions appear to elevate form over substance. Merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.

Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law. On this and other points where the application of expertise and judgment is expected, I believe that gatekeepers and others, including securities lawyers, accountants and consultants, need to focus on their responsibilities. I urge you to be guided by the principal motivation for our registration, offering process and disclosure requirements: investor protection and, in particular, the protection of our Main Street investors.

That boldface type isn’t from me – it’s from Jay Clayton. This is what a warning shot looks like, folks – and if you’ve been talking yourself into concluding that your client’s coin offering is different than all the rest, think again.

ICOs: SEC Halts ICO Offering

Just to make sure nobody missed the message, on the same day that Chair Clayton’s statement was issued, the SEC announced that it had entered a C&D order halting an ICO on the basis that it involved an unregistered public offering.

The SEC’s order is worth reading – if for no other reason than to drive home the point that a token can be a security even if it has some “utility”:

Even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labeling – such as characterizing an ICO as involving a “utility token” – but instead requires an assessment of “the economic realities underlying a transaction.” Forman, 421 U.S. at 849. All of the relevant facts and circumstances are considered in making that determination.

Interestingly, the issuer of the token contended in its offering materials that it had conducted a “Howey analysis” and that the tokens did not “pose a significant risk of implicating federal securities laws.” The SEC thought otherwise.

ICOs:  Meanwhile, Over at the Plaintiffs’ Bar…

I recently blogged that the plaintiffs’ bar has jumped in on the ICO fun – and this recent blog from Kevin LaCroix at the “D&O Diary” highlights another new securities class action suit involving a coin offering.  A company called Centra apparently raised $30 million in a token offering that was completed in October 2017.  As this excerpt notes, that’s when things got interesting:

On October 27, 2017, shortly after the company completed its ICO, Centra was the subject of an unflattering profile in the New York Times entitled “How Floyd Mayweather Helped Two Young Guys From Miami Get Rich”). Among other things, the article disclosed that on Oct. 5, the company’s co-founders, Sam Sharma and Raymond Trapani, had been indicted by a Manhattan grand jury in connection with their testimony in a July trial involving drunk-driving charges against Sharma.

The article also detailed that Sharma and Trapani had no prior professional experience associated with the debit cards they hoped to build. Their prior business experience consisted of running a luxury rental car company. The Times was also unable to confirm with the major credit card companies the supposed business arrangement Centra had described on its website.

The company subsequently announced that the two founders were stepping aside – and a class action lawsuit was filed on December 13th…

– John Jenkins