In February, the SEC announced a settlement with Gladius Network LLC (Gladius) concerning its 2017 ICO. Although the SEC found that the ICO was an unregistered securities offering without an applicable registration exemption, the agency stopped short of imposing any civil monetary penalties. In a press statement, Robert Cohen, the chief of the SEC’s Cyber Unit, said that the Gladius case “shows the benefit of self-reporting and taking proactive steps to remediate unregistered offerings.”
ICO Enforcement Action Against Gladius
According to the SEC’s order, Gladius conducted an ICO in late 2017, after the SEC concluded in its DAO Report of Investigation that ICOs can be securities offerings. As detailed in prior articles, the SEC applied the test set forth in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). In that case, the U.S. Supreme Court defined “investment contract” as a contract, transaction or scheme in which (i) a person invests money in a common enterprise; (ii) with a reasonable expectation of profits; (iii) to be derived from the entrepreneurial or managerial efforts of others.
Gladius raised approximately $12.7 million in digital assets to finance its plan to develop a network for renting spare computer bandwidth to defend against cyberattacks and enhance delivery speed. Gladius did not register its ICO with the SEC, and the ICO did not qualify for an exemption from registration requirements. According to the SEC, a purchaser in the offering of GLA Tokens would have had a reasonable expectation of obtaining a future profit based upon Gladius’s efforts to create a “marketplace” using the proceeds from the sale of GLA Tokens and to provide investors with liquidity by making GLA Tokens tradeable on secondary markets.
Gladius self-reported to the SEC’s Enforcement staff. The company expressed an interest in taking prompt remedial steps and cooperated with the investigation. The SEC did not impose a penalty because the company self-reported the conduct, agreed to compensate investors and agreed to register the tokens as a class of securities. Its order states:
The Commission is not imposing a penalty because of the significant steps Gladius took to remediate the violation. Gladius, which was evaluating the applicability of the federal securities laws to its ICO, self-reported to staff in the Commission’s Division of Enforcement in the summer of 2018, and informed Commission staff that it wanted to do what was necessary to take prompt remedial steps. It cooperated with the staff’s investigation, providing information quickly and in a form useful to the staff. It also voluntarily agreed to the remedial steps listed in the undertakings in this order, including the provision of compensation to investors.
Pursuant to the order, Gladius must return funds to all investors who purchased tokens in the ICO who request a return of funds. It must also register its tokens as securities pursuant to the Securities Exchange Act of 1934. Gladius also will file required periodic reports with the SEC.
Potential Benefits of Self-Reporting to SEC
As discussed in previous articles, the SEC has initiated enforcement actions against companies who pursued ICOs without registering them as securities. In November, the SEC brought similar charges against Paragon and Airfox. In those cases, the companies agreed to register previously issued tokens as securities and file periodic reports with the SEC. Notably, they did not self-report and were each fined $250,000.
These cases highlight that issuers of ICO tokens that meet the Howey definition of a “security,” who did not file a registration statement with the SEC or qualify for an exemption, can be brought into compliance through subsequent registration. They also demonstrate that early self-reporting will help companies avoid financial penalties.
While Gladius benefited from self-reporting to the SEC, it is imperative to discuss your unique situation with an experienced securities attorney who can determine the best course of action based on the facts and circumstances.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Paul Lieberman, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.