The SEC has become increasingly active in the crypto world in the past few months — most recently with the announced settlements involving the founder of the EtherDelta exchange and, separately, two token issuers (Airfox and Paragon). These resulted in a rare tripartite release from the SEC’s Divisions of Corporation Finance, Investment Management, and Trading and Markets. These three divisions coming together for this release — in combination with their previous actions — solidifies the SEC’s stance that they have a right to regulate a significant chunk of the crypto ecosystem, including:
- Primary Issuances, otherwise known as token sales or ICOs
- Token issuance platforms and marketplaces
- Secondary trading venues, often called exchanges
- Investment managers and advisors
While the market has reacted with surprise to these actions, many of the cases — or at least the approaches — have been previously telegraphed by the SEC. Nonetheless this recent news has caused many to suggest that “the ICO is dead.” But here at CoinList, we disagree: if you were operating compliantly before, it is business as usual. Issuers could run their token sales and airdrops compliantly before the SEC’s releases, and they can still run them compliantly today. Investors and users can still trade their tokens on secondary markets, and advisors and fund managers can still invest in tokens on behalf of others.
Here, we’ll summarize our key takeaways from these enforcement actions, discuss appropriate reactions to the recent news, and provide our guideposts for navigating a compliant crypto market.
The SEC’s Big Day
Some tokens are securities
Tokens can be securities. This is the most obvious takeaway from the multitude of SEC actions, and should not be a surprise to anyone. The difference in the Airfox and Paragon cases, as compared to previous enforcements, is that the SEC pursued issuers who were not (to our knowledge) committing fraud but instead, were violating registration requirements. This will trickle down to the whole industry. They also clarified how they might treat similar situations going forward:
- The SEC provided a path to compliance which included civil penalties, rescission rights to investors and registration/public reporting.
- The SEC continues to couch its language stating that the tokens in question were securities, but not that all tokens are securities.
- The SEC will continue to act on a facts and circumstances basis, and they haven’t provided sweeping guidance as to how to classify tokens as securities or non-securities yet.
- The SEC is requiring 12(g) disclosures for Airfox and Paragon settlements.
Existing securities laws apply to token platforms and ICO marketplaces
The Munchee action was a warning shot to platforms and service providers assisting with ICOs and marketing of tokens (including companies like CoinList). These companies are not outside the scope of the securities laws — and many of them have likely crossed a line from being a technology provider to providing services they are not permitted to conduct. Those companies and individuals seeking to directly assist issuers with fundraising should consider registering as a broker-dealer or online funding portal, or finding another compliant way to support issuers.
Secondary trading venues will be regulated
The EtherDelta action should strike fear in the hearts of all the unregulated exchanges who service U.S. investors. To the extent these assets are securities (and the SEC didn’t point to any specific token traded on the platform as a security), they have to be traded on a regulated exchange, ATS, or otherwise exempted marketplace. Although the marketplace may be founded in code, the SEC will also look to other factors including the services being rendered and form of compensation being paid to determine if registration is required.
This ruling will not impact trading venues solely focused on Bitcoin or Ether or other non-securities, but will likely cause disruption in the short term for venues supporting other assets. Fortunately there are a large number of companies in registration and seeking approval as regulated securities trading venues with both the SEC and FINRA to provide a compliant place for investors and issuers to find liquidity. Fitting the square peg of blockchain and tokens into the round hole of custody and clearance regulations has caused the approval process to be longer than for traditional broker dealers — but we still expect a solution to be found soon.
Investment managers and investment advisors are regulated
Investment advisors are not in the clear. If you are providing investment advice with respect to this asset class and/or investing on behalf of others, you need to register with the SEC (and state regulators, when relevant) or find an exemption. If these instruments are securities, or potentially securities, then the whole host of securities laws will apply to advisers and fund managers.
Exchange Act Rule 12(g) may play a part
AirFox and Paragon agreed, among other remedial undertakings, to register their respective offerings as securities, including the filing of annual and periodic reports, pursuant to Section 12(g) of the Securities Exchange Act of 1934. In the settlements, investors were granted the right, but not the obligation, to receive a refund of their investment. Those investors need sufficient information on the company to make that decision, as a result the SEC is requiring both of these issuers to provide voluntary public disclosures pursuant to 12(g) during the repurchase period (or longer).
We don’t believe this indicates that all token issuers will be subject to 12(g) disclosures, but token issuers should individually evaluate whether or not the ’34 Exchange Act Rule 12(g) applies to their issuances and consult with their legal counsel.
CoinList and compliant token sales
This increasing pace of announcements from the SEC points to a simple conclusion: the market should button up its compliance to relevant securities laws — but it doesn’t spell the end of token offerings. There have been a meaningful set of market participants that have built their businesses compliantly and have been operating pursuant to the conclusions of these actions even before they were announced.
For CoinList, the approach is relatively straightforward, even if implementation requires some expertise. For offerings considered to be of securities, in the U.S., issuers need to sell their tokens, SAFTs, or other instruments under an exemption — most commonly Reg D but also Reg CF or Reg A/A+ — and need to perform the appropriate diligence checks on their investors. If the issuer is raising capital from foreign jurisdictions, they must abide by local security laws and Reg S.
Over the past year, 40+ issuers have used CoinList to support their token sales. These issuers have raised more than $450m in capital from tens of thousands of investors from more than 50 countries around the world. There is precedent for high quality token sales, and those going to market compliantly can continue to grow and thrive.
Beyond token sales, airdrops are an incredible way to drive network activity, bootstrap users, and kickstart network effects. For airdrops involving commodities, such as Bitcoin or Ether, companies should conduct AML/KYC checks at a minimum but may likely proceed without any further registrations or exemptions.
However, if the token they want to drop is potentially deemed a security, issuers will also be required to register or find an exemption for airdropping these tokens to individuals if they involve U.S residents, even if the recipients made no investment of money.
There have been at least two instances of enforcement (Tomahawk Coin and the DAO) where the SEC has stated “free” airdrops were considered the offer and sale of securities. Specifically, in the DAO case, the SEC stated that consideration (i.e., capital at risk) was not necessary to form an investment contract that would be deemed a security under the ’33 Act. This builds on existing case law from the dotcom era, when companies were issuing equity to individuals in order to incentivize participation on their websites. There has been some disagreement in the community regarding this issue, but in the current environment the SEC has shown it is not prudent to contradict the plain language of their guidance.
At CoinList we have developed the tools for token issuers to run their airdrops in a compliant fashion. Based on current SEC guidance, this means exempting their offerings under Reg CF for the U.S. and Reg S in international jurisdictions. If issuers use these mechanisms, they can still run global airdrop campaigns to unaccredited recipients. CoinList is developing a suite of tools to reach millions of individuals including bounty programs and proof of care, characteristic-based user targeting, social referral mechanisms and much more. We look forward to supporting issuers who want to kickstart adoption of their project in a compliant fashion, while minimizing fraud, risk and theft.
Business as usual
The SEC actions were a shock to the system for some, but they shouldn’t have come as a surprise. There were some new points made, but the overall reaction should be “business as usual” rather than “the sky is falling.” Token offerings and airdrops will continue to happen using the appropriate securities exemptions, just as they have been for over a year.
If you are an issuer interesting in running your token sale or airdrop compliantly, please visit us at https://coinlist.co/tokensalemanager or https://coinlist.co/airdrops or email us at firstname.lastname@example.org.
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