Shaking the Regulatory Magic 8 Ball

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The past two weeks have been rich with information that can help predict how the SEC plans to treat companies who have issued ICOs now and in the future. Here is a quick summary of SEC actions:

  • Settlement with EtherDelta Founder in the range of $300k for running an unlicensed Money Transmitter License.
  • Airfox was found guilty of selling unregistered securities after the SEC came out with its official views of ICOs. Funds Airfox raised are being refunded to investors and the company is now required to register their tokens as securities. Additionally, Airfox will pay a $250k fine, and file periodic reports with the SEC.
  • Paragon — same punishment as Airfox.

Importantly, the SEC also released the Statement on Digital Asset Securities Issuances and Trading indicating that they will apply existing legal frameworks for securities to companies that have conducted ICOs. The general framework they have laid out is:

With regards to issuance:

  • Is the the digital asset a security?
  • If so, what commission registration requirements apply?

With regards to investing:

  • Vehicles that pool funds together with the intent of investing in digital assets need to register and follow the regulatory framework established by the Investment Company Act of 1940.
  • The Advisers Act applies to fund managers that provide advice about trading digital assets.

With regards to trading:

  • Exchanges, including decentralized exchanges, either fall under the purview of operating a national securities exchange or an alternative trading system (ATS) and must register as such.
  • An entity that facilitates the issuance and trading of securities on a secondary market must register as a broker-dealer.

For each umbrella, the SEC provided action precedents it took against a company that embodied the necessities for these rules. They have not cited, nor yet taken, public action for what would deemed “fraudulent” ICOs recently. This speaks volumes for the SEC trying to entice companies and founders to work with them to build a “path to compliance.”

This strategy holds ramifications. Initially, the SEC will probably determine that some ICOs should have registered as securities. These firms will need to liquidate in order to refund participants to their token sales, increasing selling pressure in the market. That urgency will likely increase, as there are rumored “dozens” of additional ICO investigations currently underway at the SEC. The additional oversight could cause a decrease in U.S.-based cryptocurrency innovation; larger upfront costs for increased outside counsel fees, longer timelines for project review by the appropriate regulatory body, and additional time for appropriate license and registration applications.

However, there are benefits to clear regulatory guidelines as well. The legal framework provided by US securities laws is the result of years of experience balancing the goals of investor protection and a dynamic environment for raising capital. US securities regulation has created the deepest capital markets in the world. Similarly, applying the existing framework to crypto assets benefits both investors and issuers. Investors benefit through the disclosure requirements which filter out many of the scams and poorly developed business plans that have plagued the ICO model. The issuers benefit because the investors have greater confidence in the investments they have made, reducing volatility and increasing valuations. The additional interest that regulators are taking in crypto-assets is a sign of their maturity and a recognition of their potential.

The CFTC, the IRS, and other U.S. regulatory bodies might follow a similar model of “guidance by enforcement” for projects that fall under their purview. In recent comments made to the AICPA, the new IRS Chief has vowed to hire an additional 250 special agents focusing on cryptocurrency tax issues (as well as others).

If your company has conducted an ICO or currently trades cryptocurrencies for others, there are some immediate steps that can be take to ensure that your business is in compliance with the current guidance.

  1. Contact the SEC through their Finhub page. They will assign you a representative and look over your business model to provide guidance on the appropriate registrations.
  2. Ensure that your financial records are pristine. Make sure that your business is prepared to disclose the amount you may have raised and how its spending it. If your business would like help with cryptocurrency bookkeeping, feel free to reach out to VeriLedger for assistance.

Thanks to Seth Bailey for contributions to this article.