January 5, 2018

SEC Brings Enforcement Actions Against Promoters of Initial Coin Offerings

Throughout the latter half of 2017, the SEC became increasingly focused on regulating securities law violations involving blockchain technology and initial coin offerings. A blockchain is an electronic distributed ledger maintained and broadcast by a network of computers utilizing cryptology to process and verify transactions such that all computers in the network have the same ledger.

Initial coin offerings are being used by companies to raise funds for projects by issuing virtual or digital cryptocurrencies, such as bitcoins or ethereum. Although ICOs have differed in structure, they typically involve the issuance of coins or tokens which can be exchanged for products or services from the issuing company. The SEC has become concerned about the potential for abuse in these offerings. On July 25, 2017, the SEC issued an investigative report warning market participants that sales of digital assets such as ICOs or token sales by virtual organizations may be subject to the federal securities laws as investment contracts under the Howey test. On September 25, 2017, the SEC announced two initiatives to help address cyber-based threats and to protect retail investors. The Cyber Unit focuses the Enforcement Division’s cyber-related expertise on such misconduct as market manipulation schemes involving false information disseminated through social media; hacking to obtain inside information; violations with respect to distributed ledger technology and ICOs; and unauthorized access to retail brokerage accounts. The Retail Strategy Task Force is developing initiatives aimed at identifying misconduct involving retail investors.

On December 1, 2017, the Cyber Unit filed an enforcement action against the promoters of an ICO for the “PlexCoin” proposed currency. The SEC charged the promoters with fraud, alleging that they had no intention of developing a currency and instead were using the funds that were raised for personal enrichment. The promoters were also charged with violating the federal securities laws by engaging in an unregistered offering in violation of the registration requirements of the Securities Act of 1933.

On December 11, 2017, the Cyber Unit entered into an offer of settlement with Munchee Inc., a California business that was offering Munchee tokens that would be used to improve its iPhone application, to pay users for food reviews and to sell advertisements to restaurants. In the settlement, Munchee agreed to stop offering and selling the tokens in violation of the registration requirements of the Securities Act of 1933.

The SEC has also issued a public statement that warned celebrities who promote ICOs that involve securities that they must disclose the nature, scope and amount of compensation received in exchange for the promotion. The SEC views the failure to do so to be a violation of the anti-touting provisions of the federal securities laws, presumably referring to Section 17(b) of the Securities Act of 1933.

The SEC is not the only federal agency concerned about ICOs. For instance, on October 17, 2017, the Commodity Futures Trading Commission LabCFTC Office issued a CFTC Primer on Virtual Currencies indicating that certain ICOs may be subject to CFTC jurisdiction. The CFTC has also released a customer advisory about the risks of virtual currency trading, issued a proposed interpretation of the term “actual delivery” in the context of virtual currencies under the Commodity Exchange Act, and established a virtual currency resource Web page.

This e-Bulletin was prepared by William Ross, of counsel to Hirschfeld Kraemer LLP, where he represents clients on corporate matters. Mr. Ross practices in Santa Monica, California.