Last month, SEC Chairman Jay Clayton issued a Statement on Cryptocurrencies and Initial Coin Offerings (ICOs), and although Chairman Clayton noted that the positions expressed there were his own, rather than those of the Commission, the Statement contained several important points that asset managers, sponsors of cryptocurrency funds and those selling such funds and interests would do well to keep in mind.
- Chairman Clayton acknowledged that ICOs can be effective ways for entrepreneurs to raise funding. Nevertheless, if the fund-raising involves an offering of “securities” then the offering must be accompanied by the important disclosures, processes and investor protections that US securities laws require and merely “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.”
- Since publication in July 2017 of the SEC’s Report of Investigation: The DAO, (discussed in my previous blogpost, “Cryptocurrency’s Legal Considerations for Asset Managers”, available here, some participants in the industry have distinguished “utility” tokens from “security” tokens, but Chairman Clayton emphasizes that “[m]erely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security. Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U. S. law.” Further, Chairman Clayton is especially troubled when the sponsor of such an offering emphasizes the secondary market trading potential of such tokens, where prospective purchasers are sold on the potential for the tokens to increase in value, with the ability then to resell the tokens on a secondary market for profit.
- Persons operating systems and platforms that effect or facilitate transactions in “virtual coin” offerings may be operating unregistered exchanges or as broker-dealers in violation of the 1934 Act.
- While some cryptocurrencies may not be “securities”, simply calling something a “currency” or a currency-based product does not mean that it is not a security. Before launching a cryptocurrency or a product with its value tied to one or more cryptocurrencies, sponsors must either be able to demonstrate that the cryptocurrency or product is not a security or to comply with applicable registration and other requirements under US securities laws. In addition, broker dealers and other market participants that allow for payment in cryptocurrencies, allow customers to buy cryptocurrencies on margin or otherwise use them to facilitate securities transactions must ensure that those activities do not get in the way of their AML and KYC obligations.
In light of how new cryptocurrencies are, asset managers should very carefully review the activities they contemplate in the light of applicable U. S. securities laws requirements, since failure to do so could have grave consequences for the asset manager, up to and including criminal penalties.
If you would like to discuss your firm’s participation in the cryptocurrency market as a fund sponsor, broker or market-maker, or investor, please contact me at the address below to discuss the implications of the US securities laws for that contemplated activity.
This publication should not be considered as legal opinions on specific facts or as a substitute for legal counsel. It is provided by the Law Office of John P. Ziaukas, for general information purposes and may be considered attorney advertising in some jurisdictions. All rights reserved. © 2018 John P. Ziaukas.