The SEC’s Investigative Report on ICOs is Great News
The short of it.
Yesterday, the SEC issued an Investigative Report and Press Release about their investigation of the DAO. In addition to the investigative report, the SEC issued an Investor Bulletin discussing Initial Coin Offerings.
ICOs have been a hot topic lately (and an even hotter funding vehicle) so, naturally, internet blowhards responded to the report with all kinds of doom and gloom about how today marks the beginning of the end for cryptocurrency offerings. They were, and are, wrong.
The SEC’s announcement was a reasonable and expected step. It falls in line with the market’s mounting legal consensus on the topic and was welcome news for every organization considering a legitimate initial coin offering.
The important takeaways from the SEC’s releases are two fold:
- If it walks like a duck and talks like a duck, it’s probably a duck. If a token looks like a security and acts like a security, it’s probably going to be regulated like a security.
- Cryptocurrencies are going to be judged by the same metrics as all other securities. Just because it’s called a token doesn’t mean it will get a more strict or lenient treatment.
Both of these were expected and welcome developments. They confirm popular theories within the marketplace and are a positive step toward legitimacy and stabilization for cryptocurrencies.
To understand the importance of yesterday’s releases, we need a little background. Here are a few of the relevant facts:
Prior to yesterday’s release, the SEC had not made any statement on the topics of blockchain, distributed ledger technologies, cryptocurrencies, or initial coin offerings. In their silence, legal professionals have begun to build theoretical frameworks aligned to their current understanding and practice of applicable US securities law. The core question being asked in these discussions is, “How will the SEC evaluate cryptocurrency offerings, and will cryptocurrencies be regulated as securities?”
The growing consensus has been that some cryptocurrencies will be considered securities while others won’t. Further, the growing assumption is that the determination of whether a cryptocurrency is or is not a security would be determined on the facts and circumstances of each offering.
It’s important to understand that yesterday’s Investigative Report focused on a specific cryptocurrency offering, The DAO or “Decentralized Autonomous Organization”. The DAO under investigation is a specific issuance (and one with a fascinating back story) but it is also representative of a general crypto issuance style which uses the same name: DAO.
DAO issuances carry specific characteristics and goals, the most important of which is that a DAO is effectively an investment vehicle. DAOs allow for each token holder to share in the organization’s profits, and to vote on the organization’s investments, proportionate to their token ownership. In this way, tokens act similarly to equity in form and economic reality.
What it means.
We at Thinktiv believe that yesterday’s Investigative Report and Investor Bulletin were positive developments for many cryptocurrencies specifically and for the ICO market in general. Here’s a few specific takeaways that lead us to that conclusion:
- The SEC’s treatment of the DAO was exactly as expected. Token holders of the DAO hold profit sharing, voting, and governance rights over the organization proportionate to their ownership. Practically, this makes DAO tokens a proxy for equity. In that light, DAO tokens should be governed as equity. This is consistent with the market’s prior regulatory consensus and gives us additional confidence in other aspects of market consensus that have not yet been confirmed.
- The SEC is not bringing any action against the DAO. This does not mean that the SEC won’t bring future action against new and improper DAO issuances. However, their forbearance of action here follows past patterns of enforcement for other financial innovation. It also communicates a reasonableness and temperance that some did not expect. Said another way, the SEC is acting in a predictable and reasonable manner.
- Not all cryptocurrencies are created equal. Specifically, the SEC stated that cryptocurrency offerings would be judged “…depending on the facts and circumstances of each individual ICO…” This suggests that a cryptocurrency passing the Howey Test will not be considered a security offering and would be exempt from accompanying regulation. For background the Howey test has been around since 1946 and provides a clear path for ICO issuers. This document provides an excellent adapted framework.
- You can still issue an ICO even if it’s a security. The Investor Bulletin suggests that cryptocurrency offerings can be undertaken even if they are securities so long as they adhere to existing securities law. This indicates that a future DAO offering might still move forward on well trodden paths such as traditional private registration or safe harbor exemptions (Rule 506 or others) similar to any other venture capital funding event.
What this means for you.
For the builders: If you’ve been thinking about a cryptocurrency offering for your business, all of this is great news. The SEC has reduced ambiguity in the market and begun to draw bright lines for future ICOs. Legitimate ICOs (read: ICOs with a valid token use) take heart. (And I would love to hear about what you’re building.) Scam ICOs, or equity issuers masquerading as ICOs should run for the hills.
For the investors: It doesn’t matter what you call an investment, if it looks and acts like a security, the SEC will regulate it as such. Eventual regulation and back regulation/litigation will have a negative effect on the value of coins that were issued improperly. Investors should review their holdings and seriously consider the amount of regulatory exposure in their portfolio. My guess it that most investors carry a large amount of exposure in that regard.
Ultimately, it is becoming increasingly clear that there are safe legal and regulatory paths available to organizations considering an initial coin offering. And while we continue to be vigorous advocates for retaining competent legal counsel on this issue, we are encouraged by yesterday’s releases.
Quick note: This post is designed for general informational purposes only. It does not constitute legal advice and should not be relied upon as such. In other words, go talk to your legal counsel.