Were he alive today, Shakespeare would have recognized the enormous potential in distributed ledger technology and virtual currencies. The US securities and commodities regulators also have recognized this potential, but they, unlike Shakespeare, have investor protection concerns. Jay Clayton, chairman of the Securities and Exchange Commission (“SEC”), recently reiterated these concerns in a speech at the Northwestern Securities Regulation Institute that touched on the widely reported issue of the “blockchain bump.”1
As he described it, the SEC is concerned that some public companies “with no meaningful track record in pursuing the commercialization of distributed ledger or blockchain technology . . . (1) start to dabble in blockchain activities, (2) change [their] name to something like ‘Blockchain-R-Us,’ and (3) immediately offer securities, without providing adequate disclosure.”2
Background. The SEC does not assess the merits of investing in a particular company or judge the likelihood that a company’s business strategy will succeed. Rather, the federal securities laws are a disclosure regime that requires public companies to disclose meaningful financial and other information to investors, empowering them to use those disclosures to judge for themselves if a company is a good investment decision.3
Current Developments. In recent months, a number of public companies have announced initiatives related to blockchain, virtual currency and/or initial coin offerings (“ICOs”). In many instances, these companies have no prior experience with this cutting-edge technology and may have even outsourced their new blockchain project to a third party. These companies frequently append words like “coin” or “chain” to their names, in the same way that “.com” and “e-” were added to the names of technology wannabes during the dotcom bubble. In a blizzard of press releases and whitepapers, it can often be difficult for investors to determine who is behind the latest craze and to understand their track record in the industry.
Insufficient Disclosure. The SEC’s concerns with insufficient disclosure include instances in which companies are not fully disclosing to investors their lack of prior experience in the space and the fact that they may have established legacy operations, unrelated to blockchain, that constitute the bulk of their operations (e.g., in film or tea production). Investors may be deceived into investing in a company, thinking that its name and whitepaper are evidence of its focus on the sector and potential for growth when in fact they are buying into a company with little or no experience with distributed ledger technology or, worse, a company backed by individuals with records for previous securities violations.
Celebrity Endorsements. Another concern the SEC has expressed regarding insufficient disclosure is the use, by certain companies, of celebrity endorsements in connection with their virtual currencies and ICOs.4 These celebrities are frequently compensated for their endorsements, and while they are legally required to disclose their compensation, many unfortunately do not do so. Additionally, many of the celebrities may lack expertise in the financial products they endorse, which leads to many investors acting without conducting sufficient research to make an informed investment decision.
Our Take. As always, public companies must be careful to disclose all material information regarding their operations, including past performance, other significant lines of business, resources and third-party arrangements that support new blockchain projects and the possibility that the failure of their new blockchain projects will result in losses for investors.
Companies also should disclose their relationships with persons endorsing the company or its virtual currency products, including any compensation paid. Similarly, companies should include terms in their endorsement contracts that require the person making the endorsement to disclose the nature of their relationship with the company and their expertise (if any) in the endorsed product and to comply with the anti-touting and anti-fraud provisions of the federal securities laws.