Did you know the U.S. Securities and Exchange Commission can issue subpoenas by e-mail? I didn’t.
I assumed they must communicate over a more official medium — through the mail like the IRS, or in-person like when people are served legal papers on TV. I was wrong. They e-mail.
I learned this in November 2017 when I received a subpoena from the SEC requesting more information about a project I was advising.
You may have heard of Munchee. They were covered in Bloomberg and Forbes and TechCrunch and Coindesk, but not for the reason I hoped for. They were covered because they were among the first token sales the SEC took action against and spoke about publicly.
The story is long — it’s shared, in part, here — but the short of it is this: the SEC didn’t like some of the assumptions Munchee made and, on the first day of the token sale, they ordered all funds be returned to token buyers.
Everybody knows that part of the story. Months of work by the Munchee team flushed down the drain because they made big assumptions and mistakes (which are detailed by the SEC here).
I write this post for two reasons:
- I spoke with two dozen securities or blockchain lawyers recently, and they love to say “well, you don’t want to do what Munchee did and do X.”
X is almost always something Munchee did not do and was not accused of at any point. People assign a lot of different activities to Munchee and that’s not what happened here.
- From what I saw, Munchee started on their token sale journey with the clearest intention to execute the right way and, at some point, they lost that conviction. This is easy to do. I hope that sharing their core mistakes here will help future token sales avoid them.
First, an important note:
This story and points shared herein speak to my personal experience and opinions. I do not speak on behalf of Munchee or any of its stakeholders (past or present). I was an advisor to the project and our agreement was terminated shortly after the project was halted. At that point, their counsel took charge and I was largely uninvolved. I have had very little communication with the Munchee team since that point. None of this is to be considered advice of any kind, especially legal.
The managing team was, in my experience, a group of intelligent, hard-working, and professional people. Mistakes were certainly made, but everybody (to my knowledge) had the best intentions.
The Product and Plan
Armed with complaints about restaurant review platforms and observing consumer trends toward visual user experiences, Munchee launched a simple mobile app for restaurant reviews that centered around food photography.
The experience emphasized what Munchee claimed was truly important — the food itself. The UX would discourage what they called low-quality reviews that addressed non-food factors and false reviews (as it’s much harder to fake a review if you have to produce a photo).
Their original business model was clear: restaurants would offer small items (like fries or a soft-drink) in exchange for reviews on the Munchee platform.
When management learned of the ICO market, they saw an opportunity to improve their product through token integration. If a partner restaurant incentivized users with a token, they reasoned, it might encourage more activity. The end-user could review Restaurant A and Restaurant B, earn Munchee token by doing so, and redeem those token at Restaurant A, B, C, or even D.
Look, I knew this wasn’t the next great breakthrough technology product. It was a simple iteration, a cute idea, and a twist on an existing experience.
The team, now set on executing a token sale, reached out after reading my writing in Hacker Noon. I wrote about our benjaCoin sale, the difference between utility and security tokens, my conversation(s) with the SEC, and a few other topics. (Quick aside: these posts are only 7–9 months old but they have not aged well. They may as well be from 100 years ago. So much has changed.)
I don’t need to get into detail about the token but given the information we had at the time, it seemed Munchee would be able to execute a token sale. The team was set to sell inventory (token) to a group of people who would use it for its stated purpose, they believed they would not violate the Howey Test, they weren’t going to treat it like a security in any way (via exchange listing or otherwise), and they acted in good faith.
Back then, that was (generally) enough.
Everything was going well for the first two months of our relationship. Munchee built a community around the product, earned some press, and seemed well-positioned to execute a successful small sale. And though I heard stress on the other end of the phone when I spoke with the founders, we always left our calls in a solid place.
Then the winds changed.
A few scheduled calls were missed. I would offer a piece of advice that we would seemingly agree on, but they would ignore immediately after. On two occasions, I expressed my frustrations but I was assured everything would be fine — there were some growing pains with new people joining the team, I was told, and everything would return to normal shortly.
Truth is I was being cut out. I didn’t realize it until after the fact.
Management, nervous they may not have built enough of an organic community to support a sale, brought in additional token advisors. While this is normally a welcome idea (as diversity of ideas is a good thing), these new advisors undermined the good-governance, “do it the right way” approach we had employed to that point. For whatever reason, the new advisors had the ear of management and I was the odd man out.
Munchee shifted their strategy and did three things that, in my opinion, were their downfall:
- Munchee pledged to burn whatever tokens were not sold. This was common in token sales before the end of 2017 and seems to be a thing of the past, because declaring you’ll burn token implies there will be an increase in token value. This violates Howey by setting an expectation of profit.
- Munchee ran an extensive bounty program. As I shared in “Rest in Peace, ICO Bounty Programs,” the “Howey Test labels a transaction an investment contract (and, most likely, a security) if ‘profit comes from the efforts of a promoter or third party,’ which almost always occurs when a project is promoted as part of a bounty program, and free token means there’s an implied expectation of profit.”
- Munchee turned to paid promotion. I don’t want to say I told you so, but this is something I’ve been barking about since August ’17. I told you so.
Paid promotion does not have a place in this ecosystem — ICO ads are scammy and put buyer/investor capital at risk. While it’s encouraging to see Facebook, Twitter, and Google turn token ad business away, that’s not the only place where this happens: Munchee (apparently) paid a number of YouTube influencers and bloggers to plug the project.
Not sure what I’m talking about? Let me borrow a few lines from the SEC Cease and Desist order: “Munchee created a public posting on Facebook, linked to a third-party YouTube video, and wrote “199% GAINS on MUN token at ICO price! Sign up for PRE-SALE NOW!” The linked video featured a person who said “Today we are going to talk about Munchee. Munchee is a crazy ICO. If you don’t know what an ICO is, it is called an initial coin offering. Pretty much, if you get into it early enough, you’ll probably most likely get a return on it.” This person went on to use his “ICO investing sheet” to compare the MUN token offering to what he called the “Top 15 ICOs of all time” and “speculate[d]” that a $1,000 investment could create a $94,000 return.”
That’s not the good-governance token sale I signed up for.
Token operators who try to do business in the United States and ignore these points are wrong to do so, plain and simple. Until the federal government offers a new definition for the token asset class, these actions will lead the SEC to believe the token may be a security (or at least inquire about it).
Token buyers should be weary of any American-based token sale that believes they can execute these promotion activities without registering as a security. Do your diligence and ask the questions. One thing that makes the token buyer diligence process difficult is that many in crypto media do not disclose when articles, videos, podcasts, or other content are paid — violating FTC rules. I’ll write more about this soon but if a token sale project suddenly has too much overwhelmingly positive media at once, ask questions before diving in head first. Don’t let FOMO take hold.
Today, Munchee serves as a cautionary tale — one I reference regularly and certainly learned from, and one I hope others will learn from as buyers and token operators consider their next projects.
My name is Andrew J. Chapin. I’m the CEO of Benja, the merchandise ad network, a token advisor, and the head of the startup foundry Chapin Labs which has helped launch the Coloring Crypto podcast (episode on Munchee here) and TokenList.xyz, a token listing site which promises to never accept paid listings.