ICO Issuer And CEO Settle SEC Charges For Conducting Unregistered And Fraudulent Securities Offering – Corporate/Commercial Law

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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