Introduction to ICOs
Many companies and individuals are turning to other alternative sources of funding. ICOs (or Initial Coin Offerings) are a fast and easier way to seek funding without having to worry about stringent regulations required with traditional funding.
ICOs are IPOs for cryptocurrencies. The company seeking funding creates a new coin, token, app, or service that utilizes the ICO to get funding for a venture. Investors (the public) can buy into the ICO and get new cryptocurrency tokens issued by the entity behind the ICO. The tokens can be used to buy a stake in the entity, the entity's project, or for use alongside services or products.
What Is a Whitepaper?
For an entity to launch an ICO, it needs to describe the underlying project to potential investors, the goals, capital being sought out, the number of tokens to be issued, etc. This information is found in a whitepaper.
Buying into an ICO
Once potential investors read the whitepaper and decide to invest in an ICO, they get tokens in exchange for fiat currency (USD, Pounds, Euros, etc.). Some ICOs can allow participation using cryptocurrencies.
As mentioned, the tokens/coins being bought can symbolize ownership of the issuing company or ownership in a project by the company. ICOs must be bought during a specific time frame, after which the underlying asset becomes available for the general public to trade. Participating in an ICO is important since tokens/coins are usually available at a lower price.
ICOs vs. IPOs
There are several differences between IPOs and ICOs, with the most important being regulatory differences. IPOs face more stringent regulations. The SEC (Securities & Exchange Commission) directly oversees IPOs.
However, the SEC doesn't have a clear mandate on ICOs unless they qualify as securities offerings. This makes ICOs more susceptible to fraud. They may be decentralized and dynamic; however, they face fewer regulations than IPOs.
SEC Regulations on ICOs
As mentioned, the SEC may be forced to oversee ICOs that qualify as securities. Such ICOs must be registered and subjected to similar rules as IPOs. The SEC uses the Howey Test to determine if an ICO qualifies for SEC registration. As per the test, if parties investing in an ICO expect profits derived from the promoter of the offer or a third party, that offering can qualify as a security offering. However, some other conditions apply.
Using the Howey Test, the SEC has been able to charge entities behind many ICOs. One notable example was in 2019 when the SEC charged Kik Interactive Inc for launching an unregistered ICO. In this case, the SEC charged Kik Interactive for launching an illegal offer that wasn't on par with US securities laws. The agency sought to take all profits made from the ICO.
Messaging service Telegram has also been subject to similar SEC action for attempting to launch an unregistered ICO. Telegram's unregistered ICO had already raised $1.7+ billion before being halted.
SEC Registration per the Securities Act 1933
As per the Securities Act 1933, all companies must register security offerings with the SEC. They should also disclose critical financial information pertaining to the offering to potential investors. SEC registration guidelines require registering companies to describe the offering and offer information about the financials and management of the company.
As seen in the Telegram and Kik Interactive cases, overlooking SEC registration can result in serious penalties that range from disgorgement of profits to future fundraising restrictions. Failing to register an ICO with the SEC can also lead to lawsuits from investors who can seek to get their money back plus interest and/or other damages.
However, some ICOs may fail to be registered due to exemptions. Before the SEC can charge companies for issuing unregistered ICOs, they conduct the Howey test and also check for applicable exemptions. Some other factors can also apply. For instance, ICOs advertised in a manner that indicates potential for profits can be deemed to be sold as securities offerings.
What's more, companies can structure ICO offerings to look like commodity purchases which can disqualify them from technically being considered as securities offerings. Companies wishing to bypass SEC regulations legally must avoid indicating that investors will get any benefit, right, or expect profits from the ICO.
It also helps for the token being offered to have some use besides being acquired for mere possession. Investors should have some benefits unrelated to the token's potential to rise in value. For instance, selling a token that gives the holder access to something i.e., decentralized computing power, storage, or rights to participate in a company project qualifies as a benefit unrelated to a token's rising value.
SEC registration can also be avoided legally by avoiding the term ICO in the first place. Calling your offer an ICO automatically attracts SEC attention as this is a term linked to securities offerings unless proven otherwise.
Seeking Professional Legal Assistance on ICO SEC Registration Matters
As seen above, ICOs are great sources of funding compared to traditional alternatives. However, before you launch an ICO, talk to a lawyer experienced in ICO and related matters like blockchain, cryptocurrencies, and SEC regulations.
Experienced SEC attorneys can help you determine if your ICO requires SEC registration, how to register an ICO with the SEC, how to bypass SEC registration, risks associated with ICOs, the latest regulations on ICOs, and more.
You can also get legal representation in case you are being investigated by the SEC or face charges for already launching an unregistered ICO.
The consequences of SEC enforcement actions for non-compliance such as launching unregistered ICOs include hefty fines amounting to millions, reputation damage, and possible jail time if there are crimes committed.
Contact an SEC attorney or ICO attorney immediately for SEC defense strategies and assistance on other related matters. Experienced SEC lawyers can assist with such issues.
