If ICOs are Securities: What Cryptocurrency Issuers, Exchanges and Gatekeepers Need to Know.

By: Jeff Ifrah

As predicted, the Securities and Exchange Commission (SEC) has taken additional steps to clamp down on the exploding ICO market: yesterday the Wall Street Journal  reported the agency had issued “dozens of subpoenas and information requests to technology companies and advisors.”

After repeated warnings from regulators like SEC Chairman Jay Clayton, the SEC is now sending its message loud and clear: every ICO involves the sale of a security. For background on how we got here, read our past Crypto articles.

Right now, there literally are no definitive federal rules governing ICOs: even the SEC and the Commodity Futures Trading Commission (CFTC) disagree on whether certain tokens should be regarded as securities or commodities.

The purpose of this article is to inform you, to the degree that we can, what to expect next. We look specifically at companies who have launched ICOs, are considering ICOs, serve as ICO exchanges and those who advise companies involved in ICOs, such as lawyers and bankers.

If Your Company has Already Launched an ICO:

If the government determines that your offering was a security and conducted without proper registration, it may find the ICO to be a violation of securities law. If your company has already released an ICO, your options now may include the following:

• If you are sanctioned by the SEC, you could settle by paying a negotiated fine or taking other remedial steps.
• Rescission of your original coin offering may be a possibility, but that likely will be impossible given disbursement of funds and the anonymous nature of cryptocurrency ownership.
• One best case scenario may be wishful thinking: it is possible the SEC could consider grandfathering in existent ICOs, allowing them to register and comply without overly penalizing them and forcing them out of business.
• Unfortunately, the SEC may be the least of your problems; securities class actions are likely to follow any SEC action (or even precede it).

If Your Company is Considering issuing an ICO:

• Companies currently considering an ICO may choose to pause to see how the SEC will proceed, if they have the option. This will be a more difficult decision for a start-up than for a company engaged in another line of business that was considering raising funds with an ICO.
• At this time, companies need to assess whether their business models and legal approaches are in sync. It is possible to register an ICO as a securities offering or to take advantage of one of the many registration exemptions to avoid heavy penalties. If your token is a security – or likely to be deemed one by the SEC (i.e. because you are using it to raise funds to build your platform) – those actions are advisable. Those steps may be at cross purposes, however, with your business objectives. If your model requires that your coin be freely tradeable or listed on a coin exchange, you may need to rethink the overall model, especially in terms of any anticipated capital raise.

If Your Company is a Cryptocurrency Exchange:

• Exchanges should be wary of taking on new tokens while these issues are more clearly defined.
• Exchanges may also apply for registrations and exemptions.
• Internal operations must be reviewed to ensure that tokens are exchanged only on appropriately registered platforms.

If You are a Gatekeeper:

• If you are a lawyer or banker who assists in putting together ICOs, the SEC may scrutinize your actions as gatekeeper as part of their strategy of deterrence. The agency is seeking to remove the incentive to offer ICOs in an unregulated way by sanctioning professionals who fail to act responsibly.

What’s Next?  Possible options:

The SEC is an aggressive and large regulator, but it relies heavily on deterrence to create a compliant atmosphere; it lacks the resources to pursue every company that violates securities laws. That can translate into efforts to “make examples” out of high profile investigations and settlements.  Therefore, this is a particularly perilous time for those engaging in ICOs. It is quite likely that gatekeepers (lawyers in particular) might face sanctions for ICO rollouts, and it is unlikely that the SEC will allow potential targets to be excluded by a grandfather safe harbor—all because the SEC seems intent on sending a very strong message. We expect that following this round of subpoenas, at least one set of lawyers and ICO advisors will find themselves in the SEC’s crosshairs.

Characterization by the SEC of tokens as a security will destroy many targets’ business models. Therefore, if Congress does not issue clarifying law first, we anticipate that this issue will move into the courts quickly after SEC actions are taken.

In the meantime, the ICO industry and their lawyers need to push for conversations with SEC staff attorneys to provide sensible guidance that is not based on the worst ICO actor but on the average real life ICO issuer that wants to abide by their guidance.