On January 14, 2020, the Securities and Exchange Commission’s (“SEC”) Office of Investor Education and Advocacy issued an Investor Alert urging investors to use caution before investing in “initial exchange offerings” (“IEOs”) through online trading platforms.1 This alert represents the second time the SEC issued guidance aimed at investors using online platforms to trade digital assets,2 and was likely published in response to the recent popularity of IEOs.3
While the market for initial coin offerings (“ICOs”) has slowed in recent years, beginning in 2019 IEOs became a popular fundraising trend.4 IEOs are similar to ICOs; the major difference is that IEOs are offered on behalf of issuers by trading platforms referring to themselves as “exchanges,” while ICOs are offered directly to investors by issuers.
The alert explains that IEOs are touted as an innovation on ICOs because they provide immediate trading opportunities for digital assets and because of the due diligence and other quality assessments that platforms offering IEOs claim to perform on the offerings. While investors may be enticed to invest based on the opportunity to receive high returns in a new investment space and claims by the platform that the offering was vetted, the alert cautions that IEOs present potential risks as they may be conducted in violation of the federal securities laws and lack many of the investor protections of registered or exempt securities offerings.
The key takeaways from the alert include the following:
- IEOs, like ICOs, may, depending on the facts and circumstances, involve an offering and sale of securities.
- If an IEO involves an offering or sale of securities, the platform offering the IEO may be required to register with the SEC as a national securities exchange or operate pursuant to an exemption such as Regulation ATS. Relatedly, a platform involved in the offering of an IEO also may be acting as a broker or dealer, and be required to register with the SEC and become a member of a self-regulatory organization.
- IEOs that are not offered in compliance with the federal securities laws may be missing key investor protections and remedies available under these laws. Relatedly, IEO offerings by offshore entities may nonetheless be subject to the federal securities laws, and may contain additional risks for investors (e.g., lack of information about the IEO issuer, lack of legal remedies for the investor available in U.S. courts against the offshore entity or IEO).
As the world of digital assets continues to evolve and present potential opportunities for new and innovative investments, market participants should be cautious and carefully consider the risk of each investment opportunity as well as applicability of the federal securities laws. Indeed, the SEC continues to focus on digital assets and has made clear that “market participants must continue to adhere to [the SEC’s] well-established and well-functioning federal securities law framework”5 as illustrated by this latest alert. Market participants thinking about offering or investing in IEOs should consider seeking guidance to help assess applicable legal requirements.
1. Initial Exchange Offerings (IEOs) – Investor Alert, (Jan. 14, 2020), available at https://www.sec.gov/oiea/investor-alerts-and-bulletins/ia_initialexchangeofferings.
2. Statement on Potentially Unlawful Online Platforms for Trading Digital Assets, Divisions of Enforcement and Trading and Markets, (Mar. 7, 2018), available at https://www.sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-platforms-trading. Note, this statement also contains considerations for market participants operating online trading platforms.
3. Gertrude Chavez-Dreyfuss, Explainer: Initial exchange offerings flourish in crypto market, (June 20, 2019), available at https://www.reuters.com/article/us-crypto-currencies-offerings-explainer/explainer-initial-exchange-offerings-flourish-in-crypto-market-idUSKCN1TL2E0.
4. Id. According to CoinSchedule, a cryptocurrency tracker, in the first half of 2019, IEOs raised $1.5 billion, while ICOs raised $836 million during this same time period. Id. See also Steven Russolillo, Crypto Startups Are Raising Money Again, With a Twist, (June 8, 2019), available at https://www.wsj.com/articles/crypto-startups-are-raising-money-again-with-a-twist-11559995203.
5. See supra note 3.
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.