Christopher Miglino

SEC issues public ICO-crypto statement, industry reacts

On Dec. 11 SEC chairman Jay Clayton issued a public statement on cryptocurrencies and ICOs.

Mr. Clayton said that as of Dec. 11 “the SEC also has not to date approved for listing and trading any exchange-traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies. If any person today tells you otherwise, be especially wary.”

Investors need to know that much ICO activity occurs outside of America, so regulators may not be able to pursue bad actors and recover funds.

Market professionals must provide strong disclosures and additional investor protection, Mr. Clayton added.

“A change in the structure of a securities offering does not change the fundamental point that when a security is being offered, our securities laws must be followed. Said another way, replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.”

Market professionals were urged to read the SEC’s report on the DAO debacle from July.

Mr. Clayton also singled out some market professionals who were taking great steps to suggest the coins they were promoting were not securities.

“Following the issuance of the 21(a) Report, certain market professionals have attempted to highlight utility characteristics of their proposed initial coin offerings in an effort to claim that their proposed tokens or coins are not securities.  Many of these assertions appear to elevate form over substance.  Merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.  Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law.”

The document ends with a series of suggested questions investors should ask before parting with any money. They are posted at the end of this article.

The industry has reacted to Mr. Clayton’s comments. Read their thoughts below.

Jon Chou, CEO Bee Token

Jon Chou

“According to Forbes, 9 out of 10 startups inevitably fail anyways – it’s just that the retail investor was not burned back then.

“Though I’m a big fan of decentralization, I believe that increased regulations and clarity from the SEC will help protect the average investor and increase the standard for upcoming token projects. Please read the whitepaper, review the team, and make sure it’s a project you understand and are willing to support before investing.”

Christopher Miglino chairman and CEO of SRAX and BIG Token

Christopher Miglino

“There are only a few instances that I have seen where the tokens being sold in an ICO are actually utility tokens.  The majority of them are securities trying to mask themselves as a utility to avoid the ramifications of being classified as a security in the US.

“As a publicly traded company we need to comply with these security rules and have the infrastructure to do so, something most small new companies do not.  We believe that any token used to raise money to start your project is a security and should need to follow the rules set forth by the SEC.

“One major issue these newly funded ICOs will face after they comply with security laws if they can, is how does their business work as a security token when they can no longer act as the exchange and make a market in their own token.  This is why the SEC called out the exchange rules as well.  If the liquidity for the token is cut off, the value to an investor is slashed and they are now a holder of an illiquid token with no voting rights.

“If I were the holder of a SAFT or another utility token that has not started to trade I would be very concerned.  The music has stopped and a few chairs are missing.

“If I were the holder of a security token that was registered with the SEC, I would see a significant opportunity to be one of the first registered tokens.”

Christopher Grey, COO & co-founder, CapLinked

Christopher Grey

“I think it shows the SEC is taking a gradual approach to regulation and enforcement, but they are paying attention and taking this market activity very seriously. They are particularly concerned about the risks to investors of frauds and scams as well as the risks of money laundering that could be connected with some coin offerings. People should expect more guidance as well as additional regulations and enforcement actions when regulators see causes for concern.”

Sample Questions for Investors Considering a Cryptocurrency or ICO Investment Opportunity

  • Who exactly am I contracting with?
  • Who is issuing and sponsoring the product, what are their backgrounds, and have they provided a full and complete description of the product?
  • Do they have a clear written business plan that I understand?
  • Who is promoting or marketing the product, what are their backgrounds, and are they licensed to sell the product?
  • Have they been paid to promote the product?
  • Where is the enterprise located?
  • Where is my money going and what will be it be used for?
  • Is my money going to be used to “cash out” others?
  • What specific rights come with my investment?
  • Are there financial statements?  If so, are they audited, and by whom?
  • Is there trading data?  If so, is there some way to verify it?
    How, when, and at what cost can I sell my investment?  For example, do I have a right to give the token or coin back to the company or to receive a refund?
  • Can I resell the coin or token, and if so, are there any limitations on my ability to resell?
    If a digital wallet is involved, what happens if I lose the key?  Will I still have access to my investment?
  • If a blockchain is used, is the blockchain open and public?  Has the code been published, and has there been an independent cybersecurity audit?
  • Has the offering been structured to comply with the securities laws and, if not, what implications will that have for the stability of the enterprise and the value of my investment?
  • What legal protections may or may not be available in the event of fraud, a hack, malware, or a downturn in business prospects?  Who will be responsible for refunding my investment if something goes wrong?
  • If I do have legal rights, can I effectively enforce them and will there be adequate funds to compensate me if my rights are violated?
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