As they say, everything's bigger in Texas, including initial coin offerings. A Texas federal court recently unsealed a complaint filed by the Securities and Exchange Commission (SEC) against a Texas-based company (the "Company") that presents itself as the "world's first decentralized bank" and claims to have provided "the largest ICO to date."1 Among other things, the Company is accused of engaging in the offering of securities without properly registering with the SEC and defrauding investors in the process.
Background on the Initial Coin Offering
According to the SEC's complaint (the "Complaint"), the Company was founded in March 2017 by two individuals, each of whom is named as an individual defendant in the SEC's lawsuit. The Company announced its initial plan in June 2017, and in October 2017 the Company claims to have launched its initial coin offering (ICO) first through a "private sale" that was allegedly completed in November 2017. The Company subsequently released its White Paper—outlining the Company's features, products, services, and cryptocurrency ("tokens") offered for purchase and use by investors in a variety of ways.2 In or around December 2017, the Company extended the ICO to the general public, which was set to last until January 27, 2018.3 The sale enabled consumers to purchase tokens with other cryptocurrencies or U.S. dollars, at an exchange rate of $1.40 per token for a 75-token minimum purchase.4 Tokens purchased were then kept in the consumers' Company "bank" accounts.
One selling point of the Company's ICO was its autotrading program. According to the Company's White Paper, the program utilized "digital asset-based predictive algorithms" to trade the consumers' tokens and produce daily profits.5 The Company received a 1% broker fee from the profits gained.6 The profits generated were then deposited into the consumers' "bank" accounts as a separate cryptocurrency that carried an expiration date. The Company claimed that by requiring consumers to spend the expiring cryptocurrency, it would increase the value of the tokens and drive circulation and trading among consumers.7
Allegations of Wrongdoing
The SEC claims that the Company's ICO was an offering of securities, and thus should have been registered with the SEC unless an exemption applied.8 The Complaint states that one of the individual defendants essentially equated tokens with stocks, but erroneously claimed "a private company can issue private stock to ANYONE who wants to invest in their company and/or product without the SEC's involvement in any way."9
The Company is also charged with making materially false statements and misrepresentations to consumers to incentivize them to invest in tokens. For instance, on or around January 18, 2018, the Company announced that it acquired and held "100 percent of the equity" in two U.S. traditional banks10—enabling the Company to "now offer its customers FDIC-insured accounts and transactions."11 According to the Complaint, the FDIC has no record that supports the Company's claim that it, or the banks it claims to now own, are FDIC-insured.12 In its White Paper, the Company also advertised its partnership with a VISA API to provide physical VISA cards to consumers that could be used in a manner similar to that of traditional debit cards.13 This supposed partner, after learning of the Company's claims, filed a cease-and-desist letter and denied, on social media, having any relationship with the Company and that they provided programs to enable the use of VISA cards.14
Last, the Company allegedly failed to disclose the criminal background information of two of its executive employees, which the SEC argued was material to consumers' decision to participate in the Company's ICO.15 The SEC maintains that "[t]his information—which bears directly on the honesty and professional competence of [the Company's] principals—would have been highly material to investors."16
While this suit appears to involve an ICO of a larger scale and more complex nature than many others, the lessons to be learned remain the same. As the SEC continues to focus on campaigns that involve the offer, sale, or trading of cryptocurrencies, companies considering a launch of similar campaigns should pay careful attention to SEC guidance, actions, and press releases concerning the cryptocurrency market. Moreover, individual consumers considering investing in such campaigns should research the company sponsoring the ICO, the individuals who purportedly represent the company, and claims made pertaining to the legality of the ICO.