Seven government regulators in China banned the use of initial digital coin offerings as a fundraising device (i.e., where startups distribute digital tokens to investors who make financial contributions using cryptocurrencies). According to the regulators, ICOs “are considered illegal and disruptive to economic and financial stability.” Moreover, organizations and individuals who have previously raised funds through ICOs must refund such funds “to protect investor rights.” Additionally, all China-based financial institutions and non-banking payment institutions are prohibited going forward from providing services to support any ICO. Among the government regulators issuing this prohibition are the People’s Bank of China, the China Banking Regulatory Commission and the China Securities Regulatory Commission.
Separately, the Securities and Futures Commission of Hong Kong issued a notice stating that digital tokens offered or sold as part of ICOs may constitute securities and be subject to HK securities laws. According to SFC, under HK law, digital tokens issued as part of an ICO to represent equity or ownership interests may be “shares”; digital tokens issued to acknowledge or create a debt or liability may be “debentures”; and token proceeds used to invest in projects to enable token holders to share in the return on the project may render such tokens as interests in a “collective investment scheme.” Under HK law, said SFC, shares, debentures and collective investment schemes are all regarded as securities and subject to regulation.
The Financial Industry Regulatory Authority in the United States also issued an alert to investors related to ICOs within the past two weeks.
Legal Weeds: A chilling breeze is blowing internationally regarding ICOs.
On July 25, the US Securities and Exchange Commission published a Report of Investigation that concluded that digital tokens issued by an entity for the purpose of raising funds for projects – even if using distributed ledger or blockchain technology – may be securities under federal law. If so, such securities must be registered with the Commission or eligible for an exemption from registration requirements. Moreover, the SEC concluded that any person offering trading facilities like an exchange for digital tokens that are securities must be registered as a national securities exchange or be exempt from such registration requirement. (Click here for background on the SEC’s Report of Investigation in the article “SEC Warns that Digital Tokens May Be Securitas” in an August 3, 2017 Advisory by Katten Muchin Rosenman LLP.)
Shortly afterwards, the Canadian Securities Administrators also published guidance regarding how securities and derivatives laws in Canada might be impacted by ICOs and the sales of investment funds consisting of digital tokens. (Click here for details in the article “Canadian Securities Regulators Issue Guidance on Digital Token Offerings” in the August 27, 2017 edition of Bridging the Week.)
The latest regulatory notices in China and Hong Kong, coupled with these prior advisories, likely point to the need to structure any new digital token issuance for projects as a bilateral contract for specific rights related to a project, as opposed to an investment in the project to profit mostly through the efforts of others.