Initial coin offerings (ICOs or "Token Sales") typically involve the offer and sale of digital assets utilizing distributed ledger or blockchain technology. In the past seven months, over $1 billion has been raised through ICOs, which many have predicted would lead to regulatory scrutiny.1 This prediction recently came true as the SEC's Division of Corporation Finance and Division of Enforcement issued a joint statement regarding emerging technologies, specifically citing the SEC's Report of Investigation regarding the Decentralized Autonomous Organization (the DAO) and its use of distributed ledger or blockchain technology to operate as a "virtual entity" (the "Report").2
In short, the DAO sold tokens representing interests in its enterprise to investors in exchange for payment with virtual currency. The SEC cautioned that anyone engaging in such activities should, among other things, carefully consider the application of the federal securities laws, whether (i) the transaction involves a sale of a security, (ii) the platform facilitating the transaction is operating as an exchange, (iii) the entity offering and selling the security is an investment company, and (iv) anyone providing advice about an investment in the security could be an investment adviser.3 In its corresponding press release, the SEC stated that the analysis of whether a particular transaction involves the offer or sale of a security depends on the facts and circumstances, including the economic realities of the transaction ("SEC Press Release").4 The SEC concluded that the tokens offered and sold by the DAO were securities and therefore were subject to the federal securities laws. Thus, the issuers of such tokens must register offers and sales of such securities with the SEC unless a valid exemption applies, and exchanges trading in such securities must register unless they are exempt. The SEC further indicated that anyone participating in such an unregistered offering may be liable for violations of the securities laws.
At this time, the SEC has declined to bring charges against the DAO or make findings of violations. However, the SEC has cautioned that the federal securities laws apply to those offering and selling securities in the U.S. whether (i) an issuing entity is a traditional company or a decentralized autonomous organization, (ii) securities are purchased using U.S. dollars or virtual currencies, and (iii) the securities are distributed in certificated form or through distributed ledger technology.5 The SEC further warned investors that new technologies may be used to perpetrate investment schemes and urges investors to be mindful of "red flags," including deals that sound too good to be true or promises of high returns with little or no risk. The SEC encouraged market participants employing new technologies to consult with securities counsel or to contact the staff for guidance.
To access a copy of the Report, click here.
[1] SEC Issues Warnings on Initial Coin Offerings, New York Times, July 25, 2017.
[2] Statement by the Divisions of Corporation Finance and Enforcement of the Report of Investigation of the DAO, July 25, 2017.
[3] Id.
[4] SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities, July 25, 2017.
[5] SEC Press Release.