United States: SEC Report On ICOs And Token Sales – "If It Sounds Too Good To Be True…"

Last Updated: August 18 2017
Article by Stacie S. Aarestad and Daniel S. Clevenger

On July 25, 2017, the SEC issued an investigative report to advise those who have used or may consider using a virtual organization or capital raising entity that uses distributed ledger or blockchain technology to facilitate capital raising that these activities are subject to U.S. federal securities laws. The SEC also released an investor bulletin to educate and caution potential investors about this new and growing type of capital raising.

Although the SEC determined not to pursue an enforcement action in the instant case, the report concluded that the tokens at issue in the investigation were securities and that, therefore, the offering and sale of the tokens was subject to U.S. federal securities laws. This report confirms that the SEC will look to the facts and circumstances of transactions to determine whether they constitute offerings of securities subject to U.S. federal securities laws. As such, it has broad implications for market participants that assumed sales of digital assets by "virtual" organizations (such as "Initial Coin Offerings" or "Token Sales") were outside the scope of these laws.

Summary Facts

The SEC's investigation related to the activities of The DAO, an unincorpoated organization, Slock.it UG, a German corporation, and Slock.it's co-founders and intermediaries in the offer and sale by The DAO of approximately 1.15 billion DAO Tokens in exchange for approximately 12 million Ether (ETH)1, which were valued at approximately $150 million at the time the offering closed.

The DAO is a virtual organization embodied in computer code and executed on a distributed ledger or blockchain. Slock.it and its founders created The DOA to raise funds, through the sale of DAO Tokens to investors, to fund future projects. The DAO Tokens were offered to the public without restrictions.2 Slock.it's founders promoted The DAO through media reports, website updates and online forums. Secondary trading of DAO Tokens was also supported by a number of web based platforms.3

Holders of DAO Tokens had certain voting and ownership rights. The holders would also be eligible to receive a return based on the projects funded by The DAO, which would be chosen by a vote of the holders. Proposed projects were vetted by one or more "curators" of The DAO; curators had sole control over what proposals could be submitted to and voted on by holders of DAO Tokens and ultimately funded by The DAO.

A hack occurred at The DAO during the offering period in May 2016 and approximately one-third of the total ETH raised in the offering was moved into an account controlled by the hacker. In response to the hack, Slock.it and its founders took steps designed to restore the DAO Tokens to affected holders.

Analysis

In its review of the offering by The DAO, the SEC concluded that the principles underlying the securities laws apply to virtual organizations or capital raising entities making use of distributed ledger technology. The substance of the transaction and not its novel form is determinative.

The SEC found that DAO Tokens constituted an investment contract in which an investment of money is made in a venture where the investor has a reasonable expectation of profits that would be derived from the efforts of others—the classic definition of a security for purposes of Section 2(a)(1) of the Securities Act. The fact that ETH was the currency used to purchase DAO Tokens, as opposed to cash, was found to satisfy the investment of "money" for this purpose. The efforts of Slock.it, its founders and the curators were seen as essential managerial efforts affecting the failure or success of the enterprise. The holders of DAO Tokens relied on these parties, as highlighted by the actions taken by Slock.it and its founders in response to the hacking attack.

The SEC concluded that the voting rights provided to holders of DAO Tokens, which included a vote regarding what proposals would be funded, did not provide them with meaningful control over the enterprise. The SEC noted that the ability to vote for proposals was largely perfunctory—as the proposals were subject to clearance by the curators and did not provide sufficient detail with respect to their terms. The facts that the DAO Token holders were widely dispersed, held under pseudonyms and were provided with limited opportunity for communication with other holders also, per the SEC, prevented them from having meaningful control through voting.

The SEC noted that the term "issuer" is broadly defined and includes unincorpoated organizations and that case law has upheld a flexible construction of the term to capture novel capital raising transactions. The SEC also cautioned others who participate in an unregistered offer and sales of securities not subject to a valid exemption that they may also be acting in violation of federal securities laws.

Conclusion

The SEC used its investigative report to illustrate the application of the federal securities laws to the emerging virtual markets that are operating worldwide. The analysis of the token offering by The DAO offers a roadmap of the facts and circumstances under which these offerings will be subject to U.S. federal securities laws. Because these types of offerings are expected to continue to proliferate with endless possible variations, it will continue to be a facts and circumstances determination as to the application of these laws in any given circumstance. In addition to warning virtual organizations that the securities law requires the investors receive the information necessary to make an informed investment decision, the SEC provided information directly to potential investors to educate them on the nature of these burgeoning investment opportunities.

Footnotes

1. ETH is a virtual currency based on the Ethereum Blockchain.

2. Anyone was eligible to purchase DAO Tokens. There were no limitations on the number of DAO Tokens offered, the number of purchasers or the level of sophistication of the purchasers.

3. Although the SEC's primary focus centered on the applicability of the securities laws to the offer and sale of tokens, virtual trading platforms were also cautioned that systems that meet the definition of an exchange under the Exchange Act must operate as a National Exchange or pursuant to an exemption from such registration.

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
Events from this Firm
12 Oct 2018, Other, Boston, United States

The New England Electricity Restructuring Roundtable has been meeting bimonthly since 1995 to discuss current topics related to important changes in the electric power industry in Massachusetts and throughout New England.

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