ICO issuer and CEO pay SEC fees for conducting unregistered and fraudulent securities offerings
June 28, 2021
Cadwalader, Wickersham & Taft LLP
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An Initial Coin Offering (“ICO”) issuer and its CEO have paid SEC fees for conducting an unregistered offer and sale of digital asset securities and for making materially false and misleading statements.
In the regulation, the SEC highlighted that (i) the issuer and its CEO publicly stated that the value of the issuer’s tokens was expected to increase after the ICO, and (ii) that the issuer’s management team boasted that it had “experience in Patents, inventions and blockchain technology “to increase the value of the tokens. The SEC stated that reasonable investors would expect a profit from the purchase of the tokens. The SEC found that the sale of the tokens constitutes an investment contract and therefore a security as described in the SEC v WJ Howey Co. and, as such, requires registration with the SEC.
The SEC also found that prior to the ICO, the CEO had materially misrepresented investors and the general public that (i) the issuer had paying users when it did not, (ii) that the issuer had more than 45 employees had if he didn’t have one, and (iii) that a charitable foundation was responsible for the ICO and for facilitating the liquidity of the tokens when such a charitable foundation did not exist.
As a result of its findings, the SEC determined that the Issuer and its CEO had violated Sections 5 (a) (“Sale or delivery after sale of unregistered securities”), 5 (c) (“Need to file a declaration of registration”) and 17 . have violated (a) (“Use of Interstate Commerce for the Purpose of Fraud or Fraud”) of the Securities Act, Section 10 (b) of the Exchange Act, and SEA Rule 10b-5 (“Use of Tampering and Fraudulent Devices”).
In order to settle the fees, the Issuer and its CEO agreed to (i) cease and refrain from future violations, (ii) destroy all remaining tokens, (iii) require all trading platforms to remove the tokens, (iv) the order publicly disclosed by the SEC and (v) refrain from participating in any future securities offerings for digital assets. In addition, the SEC imposed a civil fine of $ 7.6 million on the issuer and a direct lockdown on the CEO.
Commentary Conor Almquist
This regulation provides insight into how the SEC applies the Howey Test and its associated “Framework for Analyzing ‘Investment Contracts’ of Digital Assets” to determine whether a digital asset is a “security product”. Unlike the Howey Test’s broader analysis (which examines whether money is being invested in a joint venture with a reasonable expectation that profits will be made from the efforts of others) and the myriad of factors in the framework, this is where the SEC focuses almost exclusively on whether investors would reasonably benefit from the efforts of the respondent. In particular, the regulation highlights the numerous statements made to investors and on social media that “LOCIcoin” investors bought tokens at a discount and that the tokens would have a minimum value that is expected to increase as the platform continues to develop. The SEC highlighted, as respondents repeatedly indicated, that the value of the token would increase through their efforts to create demand in the market, as well as advancing the platform and making it easier to use. The SEC’s framework places great emphasis on how a digital asset is marketed to potential investors and whether it has actual value in use; these seemed to be the main factors behind the conclusion that “LOCIcoin” is a security. Companies considering offering a digital asset that should not be treated as a security should ensure that there is a fully or nearly fully developed product or related platform with a meaningful use case and avoid speculating about potential appreciation in value.
This regulation also highlights the challenge businesses face in obtaining funding to develop digital assets. If the SEC sees the sale of tokens associated with an incomplete platform as characteristic of a securities offering, how should companies support the development? Commissioner Hester Peirce’s recent Safe Harbor proposal seeks to address this issue, although it remains to be seen whether Commissioner Peirce’s proposal will find broad support.
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