“A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation,” he said. Noting that both investors and businesses have legal questions regarding certain products and offerings, he added, “The answers to these and other important questions often require an in-depth analysis, and the answers will differ depending on many factors.”
Below are five key takeaways from Clayton’s statement on ICOs:
Investors Should Be Skeptical: Clayton devoted significant attention to the risks to so-called “Main Street investors.” He emphasized that no initial coin offerings have been registered with the SEC. In addition, the SEC has not to date approved for listing and trading any exchange-traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies.“If any person today tells you otherwise, be especially wary,” Clayton warned. He also provided a list of questions that investors should ask when vetting a potential investment involving an ICO or cryptocurrency.
Labels Won’t Deter SEC Scrutiny: Clayton also addressed attempts by market professionals to highlight utility characteristics of their proposed ICOs in an effort to claim that their proposed tokens or coins are not securities. He warned, “Many of these assertions appear to elevate form over substance. Merely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security.” Clayton similarly advised, “replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.”
Support Professionals May be Held Liable for ICOs: Clayton also emphasized the role of support professionals in assisting businesses with SEC compliance. “[W]here the application of expertise and judgment is expected, I believe that gatekeepers and others, including securities lawyers, accountants and consultants, need to focus on their responsibilities,” Clayton advised. “I urge you to be guided by the principal motivation for our registration, offering process and disclosure requirements: investor protection and, in particular, the protection of our Main Street investors.”
Examples of Permissible ICOs: To illustrate the difference between an ICO that involves securities and one that does not, Clayton stated that a token that represents a participation interest in a book-of-the-month club may not implicate our securities laws, and “may well be an efficient way for the club’s operators to fund the future acquisition of books and facilitate the distribution of those books to token holders.” However, he cautioned that most ICOs are more analogous to interests in a yet-to-be-built publishing house with the authors, books and distribution networks all to come. “It is especially troubling when the promoters of these offerings emphasize the secondary market trading potential of these tokens,” he added. “Prospective purchasers are being sold on the potential for tokens to increase in value – with the ability to lock in those increases by reselling the tokens on a secondary market – or to otherwise profit from the tokens based on the efforts of others. These are key hallmarks of a security and a securities offering.”
No Bright-Line Prohibitions: While Clayton struck a cautious tone, he also acknowledged that ICOs can be effective ways for entrepreneurs and others to raise funding, including for innovative projects. “The technology on which cryptocurrencies and ICOs are based may prove to be disruptive, transformative and efficiency-enhancing,” he said. “I am confident that developments in fintech will help facilitate capital formation and provide promising investment opportunities for institutional and Main Street investors alike.”
Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Dan Brecher, at 201-806-3364.
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