The Wall Street Journal reported on Wednesday, February 28, 2017, that the Securities and Exchange Commission (SEC) has issued “scores of subpoenas and information requests to technology companies and advisers” in a sweeping probe of the Initial Coin offering (ICO) and Token Sale industry.
By way of background, ICOs or “Token Sales” typically involve the offer and sale of digital assets utilizing distributed ledger or blockchain technology. According to the report, the SEC is seeking information on the structure of these sales, including pre-sales under the “simple agreements for future tokens” (“SAFT”) framework.
We have previously written on SEC enforcement actions and public statements in this space. In short, the SEC has warned that, depending on the facts and circumstances of any particular ICO, the offering may involve the sale of a security and, therefore, may be subject to SEC (and state) regulation.
To make this determination, the SEC applies the Howey test, which looks to whether an instrument, contract, or scheme consists of the investment of money in a common enterprise with the expectation of profits derived from the efforts of others (Securities and Exchange Commission v. W. J. Howey Co., 328 U.S. 293 (1946)). The SEC has elaborated on this point in its DAO Investigative Report issued last July. Our previous posts on these actions may be found here and here.
The SEC’s reported focus on the SAFT framework raises additional questions as to how it is actually being used in this space. This is because the framework is intended to be treated as an investment contract. Because of this fact, the SAFT Framework is supposed to be limited to accredited investors and is typically issued under Regulation D, which provides for an exemption to SEC registration as long as certain conditions are met and notice is provided. Thus, compliance with U.S. securities law is contemplated under a properly executed SAFT. However, if traded through intermediaries, this could raise issues as to entities acting as unregistered broker-dealers.
While a properly structured SAFT is contemplated as a security, whether the eventual Token Sale is also a security will depend on the Howey analysis described above. And the SEC has made its position clear that the presence of a utility function alone does not end this inquiry. The reported SEC probe of ICOs, Token Sales, and pre-sales underscores the need for thoughtful, reasoned analysis and demonstrates the SEC’s continued commitment to enforcing U.S. securities laws in this space.
It is important to emphasize that the SEC subpoenas are being issued to “technology companies” and their “advisers.” This means that apparently every entity involved in the ICO process is subject to SEC scrutiny as the SEC determines the application of the securities laws to this new facet of, if the SEC is correct, the securities industry.