Man Proposes and God Disposes
On November 8, at an Annual New York City gathering of securities professionals, SEC Chair Jay Clayton went off script – and in doing so provided what is likely to be the clearest guidance we can expect to receive from the SEC in the very near future on the much debated question: when are “coins” or “tokens” securities – or not?
The consequences of guessing wrong on this one are serious and unforgiving – to both coin “issuers” and investors. There is no margin for error – and the price for those who choose to go it alone – without seasoned securities counsel – will not be insignificant.
Only two days before Jay Clayton’s remarks, in an article I penned on Crowdfund Insider calling for the SEC to provide greater regulatory clarity on the scope of its jurisdiction over ICOs, I mused:
“I obviously cannot speak for the SEC’s new Chair, Jay Clayton. But I can hope to influence thought – and perhaps successfully make the case that, as far as the jurisdiction of the SEC is concerned, we are in the midst of a crisis. And the answer is not simply general pronouncements or stepped up enforcement. What the ICO marketplace needs, at the very least, is detailed, authoritative guidance on some very basic securities issues.”
Two days later, though his remarks were lacking in detail – they were not lacking in substance or impact.
The ICO industry is now doing “damage” assessment – expect to see a great deal of industry head spinning – and pivoting.
Well, the Chair of the SEC just cut right to the chase on Wednesday, bypassing committees and formal rulemaking. His official, scripted remarks provided no new insight. But the repetition of earlier, similar SEC caveats to the ICO markets was in and of itself significant:
The Official Remarks:
Initial Coin Offerings.There is also a distinct lack of information about many online platforms that list and trade virtual coins or tokens offered and sold in Initial Coin Offerings, or ICOs. Through these platforms, individual investors can buy and sell tokens in the secondary market using virtual or fiat currencies. But investors often do not appreciate that ICO insiders and management have access to immediate liquidity, as do larger investors, who may purchase tokens at favorable prices. Trading of tokens on these platforms is susceptible to price manipulation and other fraudulent trading practices.
The Commission recently warned that instruments, such as “tokens,” offered and sold in ICOs may be securities, and those who offer and sell securities in the United States must comply with the federal securities laws. The Commission also cautioned that any person or entity engaging in the activities of an exchange must register as a national securities exchange or operate pursuant to an exemption from such registration. In addition to requiring platforms that are engaging in the activities of an exchange to either register as national securities exchanges or seek an exemption from registration, the Commission will continue to seek clarity for investors on how tokens are listed on these exchanges and the standards for listing; how tokens are valued; and what protections are in place for market integrity and investor protection.
His unscripted remarks were more impactful, as reported by Dave Michaels at the Wall Street Journal. In an article entitled “SEC Chief Fires Warning Shot Against Coin Offerings,” it reported:
“’I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security,’ Mr. Clayton said in an unscripted remark delivered in the middle of a speech at the Institute on Securities Regulation in New York Wednesday .
And the conclusion drawn by the Wall Street Journal:
“Mr. Clayton’s remarks suggest firms using the coin offerings, also known as ICOs, to raise cash in the U.S. may need to register the deals with the SEC and provide investors with extensive disclosure documents, depending on how broadly they market them. Startups that once conducted virtually unregulated token sales will likely have to consult lawyers and other gatekeepers to advise them on how to navigate laws and rules overseen by the SEC.”
An article published on CoinList had a different take:
“Implications of SEC registry means teams of attorneys for future ICOs.”
Taking a Page from the SEC’s Israeli Counterpart
Earlier that day we heard from Chair Clayton’s Israeli counterpart, Professor Shmuel Hauser, Chair of the Israel Securities Authority (ISA), from a Fintech conference in Tel Aviv, with his measured assessment of the ICO market:
“We’re going to look at the ICO industry on a case by case basis, not ban it altogether.
But first, we have to decide whether it’s a financial tool that falls under our jurisdiction. If it’s a coin and not a security, it doesn’t fall under our jurisdiction. Maybe we can regulate it through corporate laws, but not necessarily by securities laws.
I’m bothered by the lack of transparency in the ICO industry. I say to the investors – beware! It might be a bubble. And as for us, I say that what is legal now, might be illegal tomorrow.
ICOs are a part of a welcomed evolution in the funding industry. But it needs to be properly managed and regulated.”
Unlike the SEC, however, the Israeli ICA has already formed a special committee to study this area, and its findings and recommendations are expected to be reported by the end of the year – this year.
Though it is too soon to expect any formal rulemaking or interpretive releases in the US, the Commission ought to engage with industry stakeholders on a formal basis – attorneys, computer geeks, game theorists, state regulators and economists, to name a few – whether it be by way of an ad hoc advisory committee or industry roundtable. This area is complex – and practical solutions require multi-disciplinary input.
There is of course the obvious question – when should a token offering be under SEC jurisdiction?
Notwithstanding recent remarks by Chair Clayton, it is not sufficient for issuers to simply “play it safe” and find an available SEC exemption under which to conduct their “crowdsale.” US issuers will require liquid, SEC compliant secondary markets if this market is to grow and thrive under SEC regulation.
On this, tZero, a subsidiary of Overstock.com, may be the first out of the gate – recently approved by the SEC – as a registered Alternative Trading System (ATS), expected to be up and running by mid to late 2018. But to be listed for trading on tZero, your token will have to be a “security” under SEC rules. If it is not, tZero risks being shut down by the SEC as a non-compliant ATS. So unless your token is “clearly” a security, determined in the first instance by tZero, your token may wind up trading in a gray cloud somewhere.
So it is not enough for coin issuers to play it safe and find an available SEC exemption, such as a Regulation A+ offering to the public or Regulation D offering limited to accredited investors. Nor can issuers simply (safely) take the position that their tokens are not securities if they have “utility” – once the issuer launches its network – as many have done thus far.
Absent clear guidance from the SEC, rightly or wrongly, your token may find itself shut out of secondary securities markets.
In the meantime, the only safe route for any US based company seeking to conduct an ICO is to consult seasoned securities attorneys and investment professionals, and plot your best course forward in these uncharted waters.
Samuel S. Guzik, a Senior Contributor to Crowdfund Insider, is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience in private practice. Guzik is also former President and Board Chair of the Crowdfunding Professional Association (CfPA) and CfPA Legislative & Regulatory Special Counsel. A nationally recognized authority on the JOBS Act, including Regulation D private placements, investment crowdfunding and Regulation A+, he is and an advisor to legislators, researchers and private businesses, including crowdfunding issuers, service providers and platforms, on matters relating to the JOBS Act. As an advocate for small and medium sized business, he has engaged with major stakeholders in the ongoing post-JOBS Act reform, including legislators, industry advocates and federal and state securities regulators. In 2014, some of his speaking engagements have included leading a Crowdfunding Roundtable in Washington, DC sponsored by the U.S. Small Business Administration Office of Advocacy, a panelist at the MIT Sloan School of Business 2014 Crowdfunding Roundtable, and a panelist at a national bar association event which included private practitioners, investor advocates and officials of NASAA. His articles on JOBS Act issues, including two published in the Harvard Law School Forum on Corporate Governance and Financial Regulation, have also served as a basis for post-JOBS Act proposed legislation. Mr. Guzik was also instrumental in the passage of legislation in 2016 calling for the creation of an independent office of small business advocate at the SEC, and was the first person to advocate publicly for this legislation – on the pages of Crowdfund Insider.