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ICO - Initial Coin Offering

ICO Rulings – New Rules Regarding Initial Coin Offerings

ICO - Initial Coin Offering

It was just a matter of time; the SEC and other regulators are providing cautions about ICO’s (Initial Coin Offerings) as we alluded to in Bitcoin Regulation: Cryptocurrencies, AML/KYC and Compliance. After all, the regulators are there to protect consumers from security violations, financial crime, and non-disclosure of information required for potential investors to properly assess an opportunity.

With dramatic price gains by Bitcoin and other cryptocurrencies and all the hype around Blockchain, there is a lot of interest in these emerging technologies. An ICO is a way to invest on the ground-floor of one of these new opportunities. Many people see it as a way to get in on the next Bitcoin and hope for financial gain without really understanding the fundamentals or the risks of the company or technology.

With all the current hype and excitement about ICO’s, the lack of regulations makes them a potential haven for fraudsters and others who are not registering their offering or otherwise providing necessary safeguards for the public.

SEC and ICO’s

On July 25, the SEC issued an Investor Bulletin: Initial Coin Offerings and stated, “depending on the facts and circumstances of each individual ICO, the virtual coins or tokens that are offered or sold may be securities.  If they are securities, the offer and sale of these virtual coins or tokens in an ICO are subject to the federal securities laws.”

Unfortunately, the SEC statement leaves room for misinterpretation and requires further clarification, as it states, “may be securities”. There’s not a definitive ruling of what types of coins/tokens are considered securities, or which ones are exempt from security registration requirements.

It does point out, however, that each ICO will be judged on its own merits and there is the distinct possibility that federal securities laws do, in fact, apply. Complying with US federal securities laws is a complex, expensive endeavor and the penalties for non-compliance are punitive.

According to staff writer Evelyn Cheng, “For all the hype in the digital currency world about so-called initial coin offerings, U.S. investors often can’t officially participate. She continues, “Before buying one of these new digital coins … an investor typically must check a box that says he or she is not a U.S. citizen or green card holder.”

However, that might not protect the organization. If they end up distributing to US citizens, the SEC can still come after them. As BlockMason cofounder Jared Bowie states, “Any company that opens an ICO, but does not offer their token for sale in the U.S. confirms their fear that their token is at risk of SEC regulation.”

The SEC also has other concerns. On August 28, the SEC issued an Investor Alert: Public Companies Making ICO-Related Claims. This warning was for investors considering companies that are already publicly traded and are making claims regarding ICO’s. Four companies were issued trading suspensions based on their claims around ICO’s.

CSA and ICO’s

Other jurisdictions are also weighing in on ICO’s. On August 24, the CSA (Canadian Securities Administrators) issued CSA Staff Notice 46-307 Cryptocurrency Offerings. It noted that these offerings “raise investor protection concerns, due to issues around volatility, transparency, valuation, custody and liquidity, as well as the use of unregulated cryptocurrency exchanges.”

While the warnings were expected, it’s doubtful that ICOs will suddenly dry up; since the SEC’s original bulletin, according to the New York Times, 46 new coin offerings have been announced and another 204 are continuing on schedule.

There are reasons why so many recent ICOs have been successful. They offer a new model for raising funds, a new way to think of assets, risk and opportunities. Some experts are suggesting that almost everything that can be tokenized, will be tokenized. They create a way to fund new ideas, while also incentivizing those that back them a reason to use and promote them.

Accredited Investors

Any organization that wants to launch an ICO, or exchange the resulting tokens needs to be thorough in their legal structuring, documentation and due diligence. One recent example is Filecoin, which raised $187 million in one hour, using what they claimed was ‘SEC compliant’. They restricted their offering to “accredited investors”,

Under Regulation D, offerings restricted to accredited investors are exempt from having to register their securities. Companies that use that exemption need to perform proper due diligence to ensure that the investor does meet the criteria (generally, $1 million in Net Worth, not including primary residence or income of over $200,000 for the last two years).

While accredited investors might have certain business acumen, does that imply that they really understand the technology involved? Wouldn’t some computer student who understands the protocols and coding much more be more ‘sophisticated’ in the topic? Yet, there lack of wealth would prevent them from consideration from the offering.

Other factors for a legally compliant ICO are less controversial. For example, transparency is something that every potential investor appreciates. The more the team communicates their overall plans, financial structure, use of funds, incentives, associated risks, and other details, the more the public can weigh the value of the offering.

AML/KYC Compliance

Another ICO compliance factor is AML/KYC compliance (Anti-Money Laundering/Know Your Customer). While there are some people that want full transaction anonymity, governments have a legitimate reason to thwart corruption and money laundering. Taking in funds without properly performing AML/KYC checks is clearly illegal.

Consider the recent 21-count indictment and $110 million fine against Bitcoin exchange BTC-e for money laundering. As Jamal El-Hindi, acting FinCEN director, states, “We will hold accountable foreign-located money transmitters, including virtual currency exchangers that do business in the United States when they willfully violate U.S. AML laws.”

As the field develops, increasing sophistication from ICO purveyors, regulators and the public should unfold. Unfortunately, at the moment, there is a lack of clarity; organizations that go the ICO route are unsure of their legal standing, regulators don’t have clear rules for different use cases, and the public is often investing blindly. For all parties, it’s strongly recommended to do your due diligence. Through the bright light of careful due diligence, the scams and frauds will become known and the offerings that have real promise will hopefully rise to the top.

Disclaimer: Trulioo provides no warranty that the information contained in this document is accurate, up to date or complete and in no circumstance does such information constitute legal advice. Any person who intends to rely upon or use the information contained herein in any way is solely responsible for independently verifying the information and obtaining independent expert advice if required.

  • Adam

    I appreciate your efforts.
    Do you think new rules will reduce this? and what’s your opinion the voice that calls for making electronic currencies real currencies can be traded in the market and everything?

    September 11, 2017 at 12:16 am Reply
    • identicon

      Thanks Adam! Regulations will happen on a country-by-country basis, so while new rules should reduce fraudulent ICO’s in those jurisdictions, it might take time to corral them all. There’s been some investigation into developing digital fiat currencies, but it’s still premature; to scale a blockchain to put a whole economy on it is not feasible — yet.

      September 11, 2017 at 9:53 am Reply
      • Adam

        Thanks !
        this will be great for the real ICO to work well

        September 11, 2017 at 3:03 pm Reply
  • Matt

    Great article, thanks for sharing your thoughts. In your opinion, what measures should startups take in order to raise funds through an ICO while showing a minimum degree of conformity?

    September 13, 2017 at 6:55 am Reply
    • identicon

      Thanks Matt, interesting question! There are a lot of variables such as what jurisdiction you are organizing in and allowing participation from, how you structure the ICO, what is the model and how you are talking about it. The best measure is to get a lawyer to properly setup the offering.

      While ICO’s aren’t the same as going Public, following the same procedures might be a good idea. For example, be transparent in your plans and finances, be factual in your communications, and follow AMl/KYC procedures – know where the money is coming from and enable proper restrictions on the fundraising.

      September 13, 2017 at 10:40 am Reply
  • Faye

    Thanks for sharing this. For ICO who raised funds, are they financially licensed? Also, do you think they require license for doing KYC?

    March 3, 2018 at 3:26 am Reply
    • identicon

      Good question, Faye. As each jurisdiction is different, you’d have to check the regulations for your area. While a few countries have recently created specific laws around ICOs (Gilbraltar, Switzerland), most countries have not and thus it’s unlikely that licensing requirements are in place yet.

      March 5, 2018 at 11:26 am Reply
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