United States: A Shot Across The Bow—And A Welcome One

Last Updated: August 1 2017
Article by Joel S. Telpner

In the wild west of token sales, that some refer to as "initial token offerings," on July 25, the SEC finally jumped into the fray and said . . . well, actually, not that much. The SEC investigated Slock.it, a decentralized autonomous organization (DAO) organized under German law, and issued a Report of Investigation in which the SEC concluded that In the wild west of token sales, that some refer to as "initial token offerings," on July 25, the SEC finally jumped into the fray and said . . . well, actually, not that much. The SEC investigated Slock.it, a decentralized autonomous organization (DAO) organized under German law, and issued a Report of Investigation in which the SEC concluded that Slock.it violated U.S. federal securities laws in issuing its tokens because, in the view of the SEC, the In the wild west of token sales, that some refer to as "initial token offerings," on July 25, the SEC finally jumped into the fray and said . . . well, actually, not that much. The SEC investigated Slock.it, a decentralized autonomous organization (DAO) organized under German law, and issued a Report of Investigation in which the SEC concluded that Slock.it violated U.S. federal securities laws in issuing its tokens because, in the view of the SEC, the Slock.it tokens are securities under U.S. securities laws and were sold without being registered with the SEC or pursuant to an effective exemption from registration.

What did the SEC say? "Whether or not a particular transaction involves the offer and sale of a security—regardless of the terminology used—will depend on the facts and circumstances, including the economic realities of the transaction." This is neither new nor news. This has always been the case. U.S. federal securities laws are, at times, as clear as a pool of bubbling tar.

Most importantly, the SEC DID NOT close the door to token sales in the U.S. or to U.S. persons. The SEC did, however, issue an important reminder—one that many in the nascent token sale market have either forgotten or simply ignored: "U.S. federal securities laws may apply to various activities, including distributed ledger technology, depending on the particular facts and circumstances, without regard to the form of the organization or technology used to effectuate a particular offer or sale."

If a token looks like and acts like a security, it probably is a security, at least in the eyes of the SEC. Here is the takeaway—the important reminder that potential token issuers should memorize:

This [SEC] Report reiterates these fundamental principles of the U.S. federal securities laws and describes their applicability to a new paradigm—virtual organizations or capital raising entities that use distributed ledger or blockchain technology to facilitate capital raising and/or investment and the related offer and sale of securities. The automation of certain functions through this technology, "smart contracts," or computer code, does not remove conduct from the purview of the U.S. federal securities laws.

Potential token issuer, remember this and you will be well served.

The second takeaway is that if a token is a security under U.S. federal securities laws, simply excluding U.S. persons from initial token purchases will not be sufficient. Secondary trading should also preclude U.S. persons from purchasing tokens. Like most tokens, the Slock.it tokens can be resold on a number of web-based platforms that support secondary token trading. Any exchange that effects transactions in securities must be registered with the SEC as a national securities exchange unless it qualifies for an exemption from registration. So any token exchange that allows for the trading of tokens, if such tokens constitute securities under U.S. federal securities laws, would need to register as a national securities exchange (barring an exemption from registration) if the exchange can be accessed from the U.S. and U.S. persons are allowed to purchase tokens through the exchange.

Generally, securities may be sold outside of the United States without violating U.S. securities laws if the offer and sale of those securities are made as part of an "offshore transaction" and none of the parties issuing or selling the securities make any "directed selling efforts" in the United States. An offshore transaction is, among other things, one where no offer is made to a person in the United States and the buyer is physically outside of the United States or the order is executed on the physical trading floor of an established foreign securities exchange or designated offshore securities market. Directed selling efforts include any activity undertaken for the purpose of, or that could be reasonably expected to result in, conditioning the U.S. market for the securities being sold.

The above restrictions also apply to the resale of securities. Offshore purchasers can resell securities outside of the United States by following SEC regulations for offshore transactions or in the U.S. by either registering the securities or reselling them pursuant to an appropriate registration exemption. In other words, if a token being issued constitutes a security under U.S. securities laws, unless the issuer has complied with applicable U.S. securities laws, it is not sufficient to simply exclude U.S. buyers from the initial purchases of tokens. Steps must also be taken to assure that secondary sales also take place outside of the United States and are limited to non-U.S. persons.

Why Did the SEC Conclude That the Slock.it Tokens are Securities Under U.S. Law?

Determining whether something is or is not a security under U.S. law can be a complex and headache inducing exercise. U.S. law includes "investment contracts" within the laundry list of "things" that may be deemed to be securities. An investment contract includes (i) an investment of money, (ii) in a common enterprise, (iii) with a reasonable expectation of profit, (iv) to be derived from the entrepreneurial or managerial efforts of others. In the case of Slock.it, the SEC determined that the Determining whether something is or is not a security under U.S. law can be a complex and headache inducing exercise. U.S. law includes "investment contracts" within the laundry list of "things" that may be deemed to be securities. An investment contract includes (i) an investment of money, (ii) in a common enterprise, (iii) with a reasonable expectation of profit, (iv) to be derived from the entrepreneurial or managerial efforts of others. In the case of Slock.it, the SEC determined that the Slock.it tokens satisfied each of these four elements. There are many, many court cases that have dissected how broadly or narrowly each of these four elements should be treated.

After examining legal precedents, the SEC set out its argument as to why the Slock.it tokens satisfied each of the above investment contract elements. First, even though investors used a crypto currency to purchase After examining legal precedents, the SEC set out its argument as to why the Slock.it tokens satisfied each of the above investment contract elements. First, even though investors used a crypto currency to purchase Slock.it tokens, the SEC concluded that using a virtual currency nevertheless constituted an exchange of value, the equivalent of an investment of money. Second, proceeds from the initial token sale were pooled by After examining legal precedents, the SEC set out its argument as to why the Slock.it tokens satisfied each of the above investment contract elements. First, even though investors used a crypto currency to purchase Slock.it tokens, the SEC concluded that using a virtual currency nevertheless constituted an exchange of value, the equivalent of an investment of money. Second, proceeds from the initial token sale were pooled by Slock.it in order to fund projects supported by token holders and approved by curators. Third, the SEC noted that token holders stood to share in potential profits resulting from the projects funded by After examining legal precedents, the SEC set out its argument as to why the Slock.it tokens satisfied each of the above investment contract elements. First, even though investors used a crypto currency to purchase Slock.it tokens, the SEC concluded that using a virtual currency nevertheless constituted an exchange of value, the equivalent of an investment of money. Second, proceeds from the initial token sale were pooled by Slock.it in order to fund projects supported by token holders and approved by curators. Third, the SEC noted that token holders stood to share in potential profits resulting from the projects funded by Slock.it. Fourth, the SEC determined that profits are being derived by token holders from the managerial efforts of others—namely, After examining legal precedents, the SEC set out its argument as to why the Slock.it tokens satisfied each of the above investment contract elements. First, even though investors used a crypto currency to purchase Slock.it tokens, the SEC concluded that using a virtual currency nevertheless constituted an exchange of value, the equivalent of an investment of money. Second, proceeds from the initial token sale were pooled by Slock.it in order to fund projects supported by token holders and approved by curators. Third, the SEC noted that token holders stood to share in potential profits resulting from the projects funded by Slock.it. Fourth, the SEC determined that profits are being derived by token holders from the managerial efforts of others—namely, Slock.it, its co-founders and the After examining legal precedents, the SEC set out its argument as to why the Slock.it tokens satisfied each of the above investment contract elements. First, even though investors used a crypto currency to purchase Slock.it tokens, the SEC concluded that using a virtual currency nevertheless constituted an exchange of value, the equivalent of an investment of money. Second, proceeds from the initial token sale were pooled by Slock.it in order to fund projects supported by token holders and approved by curators. Third, the SEC noted that token holders stood to share in potential profits resulting from the projects funded by Slock.it. Fourth, the SEC determined that profits are being derived by token holders from the managerial efforts of others—namely, Slock.it, its co-founders and the Slock.it curators.

The SEC also had a "smoking gun" that bolstered its conclusion. At an Ethereum Developer Conference in 2015, the Chief Technology Officer of Slock.it stated that purchasing The SEC also had a "smoking gun" that bolstered its conclusion. At an Ethereum Developer Conference in 2015, the Chief Technology Officer of Slock.it stated that purchasing Slock.it tokens were comparable to buying shares in a company and receiving dividends. Needless to say, that did not help.

Does This Mean That All Tokens are Securities Under U.S. Law or That All Token Sales Must Be Closed to U.S. Markets and U.S. Buyers?

NO and NO. Some tokens are securities. Some tokens are not securities. Some tokens may or may not be securities depending on the facts and circumstances and no definitive answer may be available. If access to U.S. markets and investors are appropriate or necessary, it would be unwise as a business matter to preemptively stay away from U.S. markets and U.S. buyers without first assessing whether a proposed token would be or would likely be considered to be a security under U.S. laws and regulations.

As discussed, a number of complicated factors go into determining whether a token might be a security under U.S. securities laws. To date, there are many different types of tokens that have been issued, or are being contemplated, with many different characteristics. Some tokens, like Bitcoin, are digital currencies and would not likely be considered to be securities. In contrast, tokens that give holders ownership and profit interests are presumably always going to be treated as securities. Other tokens, however, fall into grey areas. For example, tokens that give holders the right to access a platform, provide consulting or programming services to the platform or its participants, or sell products to a system or platform or their participants may not be treated as securities under U.S. laws so long as those tokens do not have other attributes or characteristics such as the right to share profits or the right or option to purchase investment interests.

What Should Future Token Issuers Do?

If a token issuer does not need or want U.S. investors, the issuer can close the offering to U.S. persons and make sure that no solicitation or marketing activities for the tokens occur in the U.S. As noted, however, the issuer should also take steps to assure that U.S. buyers are precluded from acquiring the tokens through secondary markets and trading.

If the token is clearly not a security (for example, it is clear that it is merely a digital currency), it is not unreasonable for a token issuer to allow U.S. buyers or access the U.S. investor market. But issuers of tokens that fall into a grey area should not sell their tokens in the United States or to U.S. persons without first consulting U.S. counsel. In those cases, no U.S. counsel would be able to provide a clear opinion as to the definitive U.S. regulatory treatment of such a token. (Also, as a policy matter, the SEC will not provide advance guidance as to whether something is or is not a security.) However, a U.S. counsel would be able to help the future issuer assess the likelihood as to whether a token could be deemed to be a security under U.S. laws and regulations and could provide the issuer with guidance on minimizing the risk of such an outcome.

Many token issuers require the holding of its tokens as a condition to accessing the issuer's platform or services or in order to be able to sell services or products to, or buy services or products from, other participants of the platform, that is, other token holders. In such cases, if the issuer's token were deemed to constitute a U.S. security, unless the issuer chose to comply with applicable U.S. securities laws, U.S.-based "customers" in addition to U.S. investors would effectively be unavailable to that issuer. U.S. buyers would not even be able to acquire tokens for the purpose of accessing the issuer's business or platform. That is, if a token is otherwise determined to be a security, that treatment is the same regardless of whether a token holder acquires the token as a passive investment or holds the token as a precondition to doing business with the issuer or on or through its platform. In other words, the reason someone buys a token (for investment purposes or otherwise) is not the sole factor in determining whether that token constitutes a security under U.S. laws.

Of course a token issuer could also decide to treat a token as a security for U.S. purposes and, in order to open of the token sale to U.S. buyers, either register the token as a security with the SEC or issue the token pursuant to an available exemption from registration. Issuing a token under the requirements of the JOBS Act might also be appropriate for some issuers.

In any event, the U.S. token market is not dead. We were just given a friendly, and appropriate, reminder, that accessing U.S. buyers and markets are not always easy and appropriate preemptive legal advice is appropriate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Joel S. Telpner
Similar Articles
Relevancy Powered by MondaqAI
Carlton Fields
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Carlton Fields
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions