An initial coin offering ("ICO") issuer and its CEO settled SEC charges for conducting an unregistered offering and sale of digital asset securities, and for making materially false and misleading statements.
In the Order, the SEC highlighted (i) that the issuer and its CEO publicly stated that the value of the issuer's tokens were expected to increase following the ICO, and (ii) that the issuer's management team boasted that it had the "experience in patents, inventions, and blockchain technology" to lead to increase the value of the tokens. The SEC stated that reasonable investors would anticipate a profit from purchasing the tokens. The SEC determined that the sale of the tokens constituted an investment contract and thus, a security, as outlined under SEC v. W.J. Howey Co., and, as such, required registration with the SEC.
The SEC also found that the CEO materially misstated to investors and the public prior to the ICO that (i) the issuer had paying users, when it did not, (ii) that the issuer had upwards of 45 employees, when it had none, and (iii) that a non-profit foundation was responsible for the ICO and for facilitating the liquidity of the tokens, when such a non-profit did not exist.
As a result of its findings, the SEC determined that the issuer and its CEO violated Sections 5(a) ("Sale or delivery after sale of unregistered securities"), 5(c) ("Necessity of filing registration statement") and 17(a) ("Use of interstate commerce for purpose of fraud or deceit") of the Securities Act, Section 10(b) of the Exchange Act and SEA Rule 10b-5 ("Employment of manipulative and deceptive devices").
To settle the charges, the issuer and its CEO agreed to (i) cease and desist from future violations, (ii) destroy any remaining tokens, (iii) request that all trading platforms remove the tokens, (iv) publicly publish the SEC's order and (v) abstain from participating in any digital asset securities offerings in the future. Additionally, the SEC imposed a $7.6 million civil money penalty on the issuer and a direct bar on the CEO.
Commentary Conor Almquist
This Order provides some insight into how the SEC applies the Howey test and the related "Framework for 'Investment Contract' Analysis of Digital Assets" to determine whether a digital asset is a "security." Distinct from the Howey test's more fulsome analysis (which looks to whether there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others), and the Framework's multitude of factors, here the SEC focuses almost exclusively on whether investors reasonably expected to profit from the Respondent's efforts. Specifically, the Order emphasizes the numerous statements to investors and on social media that "LOCIcoin" investors were purchasing tokens at a discount, and that the tokens would have a minimum value that was expected to increase as the platform continued to develop. The SEC highlighted how Respondents repeatedly represented that the token's value would increase through their efforts to create demand in the market in addition to further developing the platform and its usability. The SEC's Framework places a great deal of emphasis on how a digital asset is marketed to potential investors, as well as whether it has actual use value; these seemed to be the determinative factors in the conclusion that "LOCIcoin" is a security. Firms considering offering a digital asset intended not to be treated as a security, should ensure that there is a fully or near-fully developed product or related platform with a meaningful use case and avoid speculating on any potential appreciation in value.
This Order also highlights the challenge that firms face in obtaining funding to develop digital assets. If the SEC views selling tokens linked to an incomplete platform as characteristic of a securities offering, how should firms go about supporting development? Commissioner Hester Peirce's recent safe-harbor proposal attempts to address this issue, though it remains to be seen whether Commissioner Peirce's proposal will gain widespread support.
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