The U.S. Securities and Exchange Commission (SEC) yesterday published two documents that may well have a significant impact on the future of Initial Coin Offerings (ICO). By some it is already seen as starting shot for a massive clampdown on an instrument that in recent weeks and months has gained astonishing popularity. While this is far from the end of the ICO hype, it has significant implications for existing and future fundraisings.
The regulatory silence has been deceptive. Some may have believed this could go on forever, but in reality it was only a question of time. When the DAO was attacked last year and about $50m worth of Ether were drained from it, it was the beginning of the end of an exciting project. This is not the space to go into too much detail and if you want to read more about it, why not have a look here, but what is interesting for this discussion is that Christoph Jentzsch, one of the creators of the DAO, back in the day argued that “shares in the DAO are not securities”.
Someone else in the organisation told me a while ago that regulators had decided not to go after the DAO as no investor was really damaged. Clearly, this might be a misperception as the SEC has slowly but steadily built a case and there might actually be some legal ramifications for the people involved.
What is more interesting for anyone else though, is what this report means for ICOs in general. The statement of Christoph Jentzsch and his allies already was a widely disputed one a year ago with people arguing both ways, but these arguments may be less important now that the SEC has spoken.
The SEC has spoken
Dissecting the DAO aspects from the more general ones, the SEC findings are actually more clear-cut than the sub-title of its announcement (“U.S. Securities Laws May Apply to Offers, Sales, and Trading of Interests in Virtual Organizations”) indicates: Based on the investigation, and under the facts presented, the SEC has determined that DAO Tokens were securities under the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”). The SEC clarified that to establish whether an ICO involves the offer and sale of securities, depends on the facts and circumstances of the offering.
One argument that was used in favour of the opinion that tokens should not be considered securities, was the use of smart contracts. However, the SEC report made it clear that the automation of certain functions through blockchain technology, “smart contracts,” or computer code, does not remove conduct from the purview of the U.S. federal securities laws.
What next in the world of ICOs?
What are the consequences of this decision? From the SEC’s perspective it means that it has jurisdiction over all ICOs that were open to US investors, which should be most, if not all as it is difficult to rule out entirely that some from the US participated and the only question is who has the burden of proof if it cannot be determined because of the anonymous nature of the process. The report stresses the obligation to comply with the registration provisions of the federal securities laws with respect to products and platforms involving emerging technologies and new investor interfaces. Therefore, the offer and sale of virtual coins or tokens must itself be registered with the SEC, or be performed pursuant to an exemption from registration. Everyone in the ICO business needs to comply with these requirements and related obligations. It also means that any potential wrongdoing, whether only suspected or actually justified, can be investigated by US authorities in accordance with US laws. The nasty bit is that US securities laws are rather severe and offences can have draconic consequences with many years of prison time looming in case of significant violation.
The fact that the SEC has also published an Investor Bulletin that highlights the risks in ICOs and warns against fraud and theft means that the SEC is determined to examine ICOs and go after possible offenders, so it shouldn’t be taken lightly.
Light at the end of the tunnel
It is not a bad thing for those like me that believe in the power and value of ICOs. It could potentially help separate those ICOs that are based on solid foundations and seek to add value rather than enrich the people at the expense of unwitting investors. If done properly and in accordance with the rules, it will add another layer of credibility and eventually make the whole process only stronger.