Reading the Tea Leaves: Doug Ellenoff Shares Opinion on SEC Enforcement Action Against Two Post DAO Report ICO Issuers

Last week, the Securities and Exchange Commission (SEC) announced enforcement actions against two initial coin offerings (ICOs): Paragon (Paragon Coin Inc.) and AirFox (CarrierEQ Inc. dba Airfox).

As the SEC recounted in their Administrative filing:


“Between August and October 2017, AirFox offered and then sold digital tokens (“AirTokens”), which were issued on a blockchain or distributed ledger. Through this initial coin offering or ICO, AirFox raised approximately $15 million in capital for the purpose of creating and capitalizing a new, international business and ecosystem. AirFox told investors that the new ecosystem would include the core functionality of AirFox’s existing U.S. business—allowing prepaid mobile phone users to earn free or discounted airtime or data by interacting with ads — and would also add new functionality, including the ability to transfer AirTokens between users, peer-to-peer lending, credit scoring, and, eventually, using AirTokens to buy and sell goods and services other than mobile data. In connection with the offering, AirFox stated that AirTokens would increase in value as a result of AirFox’s efforts, and that AirFox would undertake efforts to provide investors with liquidity by making AirTokens tradeable on secondary markets.”


“Paragon is an online entity that was purportedly established to implement blockchain technology in the cannabis industry. From August 2017 through October 2017, Paragon offered and sold digital tokens (“PRG” or “PRG tokens”) to be issued on a blockchain, or a distributed ledger (the “offering”). Paragon conducted the offering of PRG tokens to raise capital to develop and implement its business plan to add blockchain technology to the cannabis industry and work towards legalization of cannabis. In connection with the offering, Paragon described the way in which PRG tokens would increase in value as a result of Paragon’s efforts and stated that PRG tokens would be traded on secondary markets. Paragon raised approximately $12 million worth of digital assets during the offering. Paragon did not register the offering pursuant to the federal securities laws, nor did it attempt to qualify for an exemption to the registration requirements.”

In the opinion of the SEC, both of these issuers transgressed current securities law.

Additionally, both issuers decided to flout the SEC’s DAO report, a line in the sand statement by the SEC, that ICOs would be considered securities offerings and issuers should register for an exemption.

The DAO report came out in July of 2017 and the two aforementioned issuers were raising money by selling their tokens after the DAO report was published.

As part of the settlement between the two ICO issuers and the SEC, both companies are compelled to rescind the offer to investors: in brief, both Paragon and AirFox must give all the money back.

Additionally, both companies are required to pay hundreds of thousands of dollars in fines. The ICOs that quickly raised millions of dollars may now lose all of that money and quite a bit more.

ICO issuers everywhere that did not file for an exemption should be reading about these enforcement actions with great interest – especially if you took money from US investors and even more so if you did it post DAO.

CI decided to reach out to Doug Ellenoff, Managing Partner of Manhattan law firm Ellenoff, Grossman & Schole, for his perspective on the SEC enforcement action.

More than a year ago, Ellenoff was sounding the warning bell about ICO issuers ignoring existing securities law. He was stating at that time that it was unquestionable and inevitable that the SEC would take action.

“Don’t take their inaction at this juncture as any kind of endorsement or acceptance. It doesn’t work that way,” said Ellenoff.

This past week’s actions by the SEC against ICOs may just be the start.

Below is our conversation with Ellenoff.

What are the takeaways from the SEC action against the two initial coin offerings  (ICOs) – Paragon and Airfox?

Doug Ellenoff: There should be no surprise in the action or messaging of both these [SEC] enforcement actions.

Recognizing that the ICO industry was premised on faulty legal analysis, the SEC sent a very tactical warning shot in the DAO case that there was at that time misinformation being relied upon to conclude that token offerings weren’t a security and even went as far to suggest that they wouldn’t enforce against those that had violated the securities laws up until that time with their ICOs.

Frankly, I admired their restraint in the face of cynical noncompliance and no one should be surprised by the selection of any ICO issuers post-DAO who continued to ignore the flags on the field.

The SEC sought to balance innovation in the Fintech space with real concerns for investor protection.

When you look at the significant losses suffered by investors it is hard to argue that the SEC has been overzealous. The specific takeaway here is there is one set of securities laws and tokens must comply with the established rules and regulations of capital formation.

As a caution, this applies equally to the secondary trading of tokens.

Does this mean that all pre-DAO issuers get a pass?

Doug Ellenoff: While there can’t be any assurances in that regard, for the SEC to announce these two particular ICOs and to highlight that they were post-DAO, an ICO issuer pre-DAO should take some comfort that the SEC is following the roadmap that they indicated in DAO. [There is] the caveat that an ICO issuer pre-DAO that either misappropriated funds, or acted grossly negligent, probably has continuing exposure.

Any thoughts on the penalties handed out by the SEC? Is this just a slap on the wrist?

Doug Ellenoff: Any issuer that ends up with financial penalties only should be appreciative of the SEC’s restraint IMHO.

What should all post-DAO ICO issuers be doing now?

Doug Ellenoff: Call their securities lawyers.

This isn’t just self-serving but a further admonition that issuers need to appreciate that they have raised funds in a securities transaction and must comply with all securities laws; federal, state, and international.

I can’t emphasize enough that innocent investors have lost substantial sums of money due to unlawful behavior and that this is quite serious.

Today’s cases specifically mentioned that much of the issuances were conducted outside the US – thereby indicating that those issuers have exposure to foreign regulators as well.

The roadmap is to offer rescissions to your investors if you didn’t comply with the securities laws in the first instance and again, pay particular attention to secondary trading issues and blue sky laws.

Neither the SEC nor other regulators are going to continue to look the other way on violations based upon “innocent” mistakes in judgment.

Does this also provide a clearer path for ICO or STO issuers?

Doug Ellenoff: STOs are merely securities with embedded blockchain recordation of ownership. It is arguably better than using a transfer agent, yes, but make no mistake about it, tracking ownership of public securities has been a profession in good standing for a long time with few problems.

An STO is merely an acknowledgment that an ICO is a security.  Realistically, they always were and so it isn’t unfair to argue that this is merely a rebranding of a now maligned mechanism for raising funds for entrepreneurs.

Don’t get me wrong though, I am all for compliant STOs, blockchain and smart contracts.


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