ICOs the New IPO? SEC Enforcement and When an ICO is a “Securities Offering”

Traditionally, a company seeking to raise capital might do so by conducting an initial public offering (IPO), and investors participating in the IPO would obtain an ownership stake in the company. However, with the introduction of cryptocurrencies and digital tokens, new ways of raising capital and entering the public market have emerged over the last few years. Initial coin offerings (ICOs) function similarly to IPOs in that ICOs help companies raise funds, yet there are many distinctions between the two similarly named phrases. For example, participants in an ICO receive tokens, which may serve any number of functions (including early access to a product or service, membership on a platform, voting rights, an ownership interest, and more), whereas participants in an IPO solely receive an ownership stake in a company.

While ICOs have existed since 2013 with the launch of Mastercoin (now called OmniLayer), ICOs gained significant momentum in 2017 and, as a result, also gained the attention of the U.S. Securities and Exchange Commission (SEC). By September 2017, the SEC created the Cyber Unit within the Enforcement Division to combat securities violations involving cryptocurrencies, distributed ledger technology, and ICOs. On December 1, 2017, the Cyber Unit filed its first charges and obtained an emergency asset freeze to halt an ICO. The complaint charged Dominic Lacroix, his company PlexCorps, and his partner Sabrina Paradis-Royer with violations of the registration requirements under U.S. federal securities laws. The full press release is available here.

Just over a week later, SEC Chairman Jay Clayton released a statement warning investors to be cautious when considering the purchase of cryptocurrencies and suggesting that ICOs and other digital token offerings could trigger federal securities laws. The Chairman stated in the release that “[a] change in the structure of a securities offering does not change the fundamental point that when a security is being offered, our securities laws must be followed.” The Chairman also noted that an ICO would not trigger registration requirements if the offering meets the criteria of one of the SEC’s registration exemptions. The full statement is available here.

Despite the SEC’s warnings in late 2017, the regulator did not have any significant enforcement actions related to cryptocurrencies until just a few weeks ago. On November 16, 2018, the SEC announced that it had settled charges against two companies that issued tokens in ICOs, for failure to comply with registration requirements that apply to securities offerings. The full press release is available here, and a discussion of the settlements and recent litigation surrounding virtual currency exchanges can be found in the Michael Best Banking & Financial Services Newsletter, available here.

These two settlements mark the SEC’s first cases imposing civil penalties on issuers of digital tokens for violating securities offering registration requirements. The Directors of the SEC’s Enforcement Division warned that the same fate could befall other companies considering ICOs that do not first examine the application of federal securities laws. Going forward, we will likely see an increase in enforcement actions against companies conducting ICOs that are not in compliance with applicable federal securities laws. This raises the question: is an ICO that much better than an IPO for raising capital, if the same legal and regulatory burdens apply? We’ll be keeping a close eye on this, as the market for ICOs has already significantly tapered off. 

See our other blog posts here and here on the application of state and federal securities laws to ICOs, cryptocurrencies and digital tokens. Michael Best’s Blockchain, Digital Currencies & Smart Contracts team has also made available several webinars and presentations here on this topic.

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