understanding the sec investor bulletin on initial coin offerings
The Securities and Exchanges Commission (SEC) turned an otherwise dull July Tuesday into a turning point in the development of Blockchain-based virtual coin or tokens in the USA when it released an Investor Bulletin on Initial Coin Offerings in the USA (‘Bulletin’) on July 25, 2017. The SEC Bulletin which was not expected by most experts in the sector and came as a reminder that the SEC is keeping a close eye on the development of the blockchain and virtual currency sector in the United States. It showed that SEC was willing to step in to regulate the sector if it saw any developments, which can be considered even remotely connected to securities trading.
For beginners, the SEC as its name appropriately describes is a regulatory agency of the US Government dealing with the regulation of the securities and exchange market in the US. The SEC aims to protect the US investor and promote efficient and transparent capital markets. It deals with securities (including exchanges and dealers), mutual funds and also advisors.
The SEC has traditionally dealt with securities offerings by companies, but through the July 25Bulletin, the SEC has explained that it is aware that a new generation of companies has sought to raise funds through ‘Initial Coin Offerings’ (‘ICO’). The ICO process refers to the selling of virtual coins or tokens (‘VC’) issued by a company or capital raising entity for fiat currency, funds or even other types of virtual currency. These VC are frequently based on distributed ledger or blockchain contracts which work on the basis of computer code. According to the SEC, the VC can be ‘a digital representation of value that can be digitally traded and functions as a medium of exchange.’ The SEC highlights that the exchange of fiat currency or funds to VC takes place in Virtual Currency Exchanges (VCE). The SEC has also underlined the role of ‘virtual organizations’ or other capital raising entities that create these VC.
The main observation which the SEC has made through the Bulletin is that “in certain cases, the tokens or coins will be securities and may not be lawfully sold without registration with the SEC or pursuant to an exemption from registration.” It further goes on to state that VCE ‘may not be registered securities exchanges or alternative trading systems regulated under the federal securities laws.’ The SEC has also tried to distinguish between Crowdfunding contracts and ICO’s and has asked people to evaluate compliances with crowdfunding regulations and also securities law.
The Bulletin by SEC has come as a largely positive development for the ICO industry as for the first time; it has a firm reference point to fine-tune its operations and avoid future hurdles. Contrary to the highly negative initial interpretation of certain industry commentators wherein they perceived the SEC Bulletin as a potential death knell for all ICO and suggested that all future ICO will have to be registered with the SEC, the SEC has issued a relatively open-ended statement.
The SEC has merely stated that “depending on the facts and circumstances, the offering may involve the offer and sale of securities”. It has also stated certain requirements “if the virtual token or coin is a security.” The use of the word ‘may’ and ‘if’ in these sentences show that any VC may not necessarily be a ‘security’ and every ICO process may not be a sale of ‘securities.’ The assessment would depend on a case by case analysis and would also necessarily involve an evaluation of the rights which are derived from the rights acquired through the purchase of the VC and if the rights which are granted may potentially make it a ‘security.’ The exact evaluation of what may be considered as a ‘security’ is open to interpretation and a qualified attorney may be able to make a more precise assessment depending on individual circumstances. For those interested in the subject, a reading of the definition of ‘security’ in Section 2 (a) (1) of the Securities Act, 1933 may be a good start.
For the industry and investors alike, the SEC Bulletin and the DAO Investigation Report broadly highlighted the loopholes and the necessary improvements required in the ICO process to comply with regulations. Additionally, it will help the industry determine the exact nature of ICO’s that they seek to issue, the characteristics which will be associated with the VC and if they would actually want to issue an ICO in the US or target US investors. The investor, on the other hand, will have greater clarity on the value of his VC and the remedial options before him in case his investment is affected.
From an initial assessment of the ICO process and the SEC Bulletin, we have understood that VC’s may be considered to be of three main categories- Coin not as a security, coin as a security, coin as an option, warrant or a swap. Depending on this understanding, certain forms of ICO’s may be required to register as a security, commodity or even in the money services business. In some cases, the VC may have multiple forms and may fall into multiple categories.
For ease understanding and ready reference, the following table might be used although it is not comprehensive:
We at Empire Global Partners are continually following the developments arising in the rapidly changing ICO sector and will provide you immediate updates on any changes arising in the future. We have a team of experts ready to help you with the preparation of an ICO and setting out the documentation required for the process. You can reach the experts at Empire through phone at +60350331665, by our website www.empireglobal.partners and or by email at firstname.lastname@example.org. We offer clear written contract agreements clearly mentioning the applicable charges including the refund policy, in the unlikely event that the application is unsuccessful.