SEC on ICOs: Securities are securities, but..

The big news in the ICO sphere today is that the SEC has deemed that the DAO Tokens were likely securities, indicating that securities laws may apply to token sales.

While I am not a lawyer, I have been a hedge fund manager for over a decade and know that you never want to mess with the SEC.

As such, we were very careful when structuring our own token, the Anacoin (designed to help in the fight against extremism). issued by the Ananas Foundation, to make sure that it didn’t fall under the categorisation of a security and hopefully form a template for charitable fund raising.

The standard measure for whether something is a security is the Howey test, based on the case SEC vs W. J. Howey from 1946, which would then require they be registered with the SEC per the 1933 Securities Act.

This has been pored over in a number of pieces, including this excellent white paper by Coinbase, but the bottom line is that there are three key characteristics a security fits:

  1. An investment of money — most tokens/ICOs these days
  2. In a common enterprise
  3. With an expectation of profits predominantly from the efforts of others

This has been treated a bit fuzzily by some tokens, but the SEC has now been clear that the DAO Tokens fit under this definition.

Specifically, the SEC noted that a security includes an “investment contract”, which is an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others”.

Investment of money can be any consideration, including Bitcoin or Ether.

The expectation of profits section is particularly interesting as the SEC notes: “[P]rofits” include “dividends, other periodic payments, or the increased value of the investment.”, which is wider than most think. Slock.it (the promoters of the DAO) also noted that the DAO was a “for-profit entity whose primary objective was to fund projects in exchange for a return on investment”.

Some arguments that the DAO would not fall under securities law rested on the belief that the profits would not be derived from the managerial efforts of others due to centralisation, focusing on the word solely/predominantly.

However, in the case of the DAO there was distinct centralisation under the specific Curators of the DAO. The test is also whether “whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.”, where Slock.it was certainly crucial to the managerial success of the enterprise, with DAO holders voting rights limited.

While the SEC was reiterating what was known before as unregistered security sales were always illegal, the clarification on certain definitions should hopefully lead to a tightening up on token sales that vastly over-promise on profits (hint: if a token sale guarantees a profit, it is a scam, if it promises a share of revenues/profits it is probably a security).

For token sellers who fly too close to the wind and sell effective securities to US investors (sICOs?), they may want to look into rescission laws (curiously this might be bullish for Bancor as it can provide auto-rescission..).

This should also be bullish for ICOs that have taken the time and care to implement KYC checks like the upcoming Filecoin sale (do check their docs) and increasing enforcement may start to weed out some of the lower quality sales we have been seeing.

Other jurisdictions may follow, but a general (very general) rule of thumb is that the closer a token is to an API key or scarce digital asset, the more assured you can be.

Having said that it could still be counted as property per other US regulations and you should make you have your capital gains taxes in order..

Those thinking of becoming involved in ICOs or wishing to learn more should also read the SEC’s actually quite good investor bulletin on the topic.

In the next post we will discuss how we have tried to use token best practice for our Anacoins and the “tokenomics” (sorry) of the Ananas ecosystem.