The US Securities and Exchange Commission’s (SEC’s) Investor Education and Advocacy division is warning the public that, because both Initial Exchange Offerings (IEOs) and the platforms selling them may be unregistered and unregulated, investing in IEOs may be high risk- and not much different than investing in ICOs.
IEO’s emerged in 2018 after a number of SEC communiqués and enforcements made it clear that the regulator largely regards ICO’s (initial coin offerings) as unregistered securities.
According to the SEC, IEOs are differently named but similarly featured. The only difference is that, rather than being sold directly to investors by ICO projects themselves, IEO’s are sold by trading platforms where they can also be traded:
“Initial exchange offerings (IEOs) are a recent development in the rapidly evolving digital asset space. IEOs are similar to initial coin offerings (ICOs) in that they are initial offerings of digital assets (e.g., coins or tokens) to raise capital. However, IEOs are being touted as an innovation on ICOs because they are offered directly by online trading platforms on behalf of companies—usually for a fee—to provide immediate trading opportunities for the digital assets.”
First, the word “exchange” is a misnomer, the SEC claims:
“These online trading platforms, which are typically not registered with the SEC and which may improperly refer to themselves as ‘exchanges,’ may also claim to perform due diligence or other quality assessments of the IEOs.”
Because the platforms are not true and regulated exchanges, using them implies considerable risk:
“Noncompliance with the federal securities laws means the IEO and/or trading platform may be operating unlawfully and the investor and market protections and remedies these laws are intended to provide may be absent.”
“You should carefully consider whether the company and the trading platform involved in the IEO has complied with federal securities laws.”
IEO’s may be cleverly marketed, but, “Be cautious if considering an investment in an IEO,” the SEC writes:
“Claims of new technologies and financial products, such as those associated with digital asset offerings, and claims that IEOs are vetted by trading platforms, can be used improperly to entice investors with the false promise of high returns in a new investment space. As described below, IEOs may be conducted in violation of the federal securities laws and lack many of the investor protections of registered and exempt securities offerings.”
According to the regulator, a failure to reference securities laws in an IEO offering is “a red flag”:
“It is a red flag if the IEO and its participants, including the online trading platform, do not address or discuss the applicability of the federal securities laws.”
Projects may also claim they are registered when they are not:
“Saying something is registered doesn’t make it so. In addition, be careful if the promoter of the IEO or the digital trading platform hosting the IEO states that they are approved or registered with the SEC.”
“There is no such thing as an SEC-approved IEO.”
American securities laws are thorough -some would say too thorough- though SEC Chair Jay Clayton has defended the standards claiming they help assure that U.S. remains a safe place to invest money.
Strong rules have meant that even cryptocurrency projects and trading platforms with premises and staff in the US are registered offshore.
Rules at offshore businesses may be loosely enforced. Cryptocurrency trading platforms like Bitfinex and BitMEX, for instance, have been accused of only tacitly enforcing stated policies barring American traders.
Though, “Projects may claim to be exempt because they are located overseas,” the SEC warns, “…if the offering is being made to American investors, American securities laws may apply,” meaning IEO offerings may be non-compliant (and subject to future enforcement action?).
Furthermore, “Offshore trading platforms that attempt to avoid regulatory scrutiny can leave investors without important information,” the SEC writes, “including information about the IEO issuer, the digital asset offered, and any arrangements between the trading platforms and IEO issuers that enable them to make informed judgments about whether to invest in an IEO.”
Distance can also mean poor oversight regarding trades and conflict of interest at exchanges. Popular crypto trading platforms have been accused of using order data to trade against their own customers and conspiring amongst themselves to manipulate the prices of cryptocurrencies.
For example, executives at Korean crypto trading platform Komid were prosecuted for consducting alleged billion dollar wash trades designed to give customers the false impression that the exchange and the “crypto assets” on it were very popular.
Importantly, if an investor ends up defrauded by a foreign entity, the SEC warns, there may be little recourse.
Defrauded investors, “may have no effective legal remedies in U.S. courts against offshore trading platforms or IEOs issuing on the platforms. Even if investors sue successfully in a U.S. court, they may not be able to collect on a U.S. judgment against a foreign company, entity or person.”
As well, collecting relief in such cases would, “rely on legal remedies in a foreign country. These remedies may not exist or may differ greatly from remedies available in the United States.”