IEO (initial exchange offering) “fever” is proving more short-lived than the ICO (initial coin offering) version, and that is probably a good thing.
By promoting “IEOs” –crypto tokens of a slightly different stripe– exchanges and pundits have hoped to revive some of the excitement, action, and profits experienced in 2016 and 2017
By pivoting away from ICOs (sold directly to unaccredited buyers) to IEOs (sold first to vetted investors by exchanges, then listed on said exchanges to be sold to the general public), exchanges hope to sidestep securities laws they find onerous while perfunctorily acknowledging that they can’t sell directly to Main Street.
But according to former SEC Internet Enforcement Chief John Reed Stark, who provides a must-see take via LinkedIn, IEO’s directly contravene US securities laws, and:
“Purveyors, promotors and others associated with IEOs conducted in U.S. markets and involving U.S. investors had best prepare themselves for an SEC IEO enforcement onslaught.”
The conclusions in Stark’s comprehensive and cogent piece on the IEO phenomenon do not bode at all well for IEO issuers.
By brokering tokens, even to vetted investors, platforms not licensed to do so have acted as broker-dealers and BOTH exchanges and issuers in these circumstances may be putting investors at risk:
“By skirting broker-dealer registration requirements, cryptocurrency trading platforms peddling IEOs are not adhering to a financial services regulatory framework meticulously harnessed to protect investors.”
SEC Associate Director of the Division of Corporation Finance and Senior Advisor for Digital Assets and Innovation Valerie Szczepanik unequivocally warned the crypto industry regarding IEOs at the last Consensus Conference in New York, which took place May 13-15.
“Most obviously, cryptocurrency trading platforms seeking to list these tokens for a listing fee or bring buyers to the table for issuers are probably engaging in broker-dealer activity . . . If they are not registered, they will find themselves in trouble in the U.S., if they have a U.S. issuer or U.S. buyers, if they are operating on the U.S. market.”
According to Reed, “Szczepanik is a seasoned and well-respected SEC veteran…not known to make empty threats.”
For years, ICO issuers and their lawyers pleaded ignorance and stated that they could not be expected to clearly understand how securities laws applied to the tokens being sold to the public.
Those claims became impossible, though, Reed reminds readers when the SEC issued its Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO.
Reed provides an excellent insider’s summary on the findings of “the SEC’s DAO Report,” as it has come to be known.
Suffice it to say that claims of token’s future “utility” on a forthcoming network were not determined to exempt the tradable token from being classed as a security.
And, simply put, though exchanges claim they are avoiding unaccredited investors, they are still acting as broker-dealers under US law, and doing so has potentially serious consequences:
“The ramifications for failure to register as a broker-dealer are severe, even criminal. In addition, Section 20(e) of the Exchange Act, under which the SEC may impose aiding-and-abetting liability on any person that knowingly or recklessly provides substantial assistance in a violation of the Exchange Act, creating additional potential liability. Finally, merely retaining and permitting an unlicensed intermediary to help facilitate or effect a securities transaction (such as an IEO) may be a violation of federal and many state laws and may subject the IEO issuer (i.e. the fundraising entity) to possible civil and criminal penalties, including imprisonment.”
Notably, neither of the two biggest US crypto trading platform, Coinbase nor Kraken, has announced plans to host IEOs, but their overseas competitors Binance and Kucoin, have done IEOs, via Launchpad and Spotlight platforms, respectively.
But if those platforms can be proven to have facilitated the selling of IEO tokens to US investors, they could find themselves under US jurisdiction.
Behaving as a securities broker is not simply a matter of determining a market and selling to it, Reed writes:
“…(B)roker-dealers are required to observe high standards of commercial honor and just and equitable principles of trade’ in the conduct of its business, including determining if an investment is ‘suitable’ for its customer and maintaining meticulous records of communications, representations, transactions and other important information. Broker-dealers also are subject to SEC and FINRA examinations together with an exhaustive laundry list of regulations and rules of conduct as well as a rigorous training, testing and certification process.”
If a securities seller does not enforce these standards upon themselves, the SEC is mandated to do so, Reed writes:
“The SEC has an entire division dedicated to broker-dealer registration; will not hesitate to enforce broker-dealer registration provisions; and enjoys an extremely low legal threshold to insure victory in any broker-dealer registration enforcement action, key indicators for a successful SEC IEO enforcement program.”