On December 11, 2017, the SEC released a cease-and-desist order against digital tokens sold by Munchee Inc. (“Munchee”) along with a press release and a statement by SEC Chairman Jay Clayton on Cryptocurrencies and Initial Coin Offerings (“ICO”), evidencing its continued focus on this emerging area and the potential regulatory issues within it.
Munchee is a California business that created an iPhone application for users to review restaurant meals. In October and November 2017, Munchee offered and then sold digital tokens (“MUN tokens”) to be issued on a blockchain. Munchee was seeking $15 million in capital to improve its app and to create an “ecosystem” in which Munchee and others would buy and sell goods and services using the MUN tokens.
According to the order, in connection with the offering, Munchee described the manner in which MUN tokens would increase in value as a result of Munchee’s efforts and stated that MUN tokens would be traded on secondary markets.
As the SEC has said in its DAO Report of Investigation, a digital token can be a security, and more specifically an “investment contract,” pursuant to Section 2(a)(1) of the Securities Act. This determination is based on the Howey test, which involves assessing whether investors’ profits are to be derived from the managerial efforts of others. A more detailed explanation of the Howey test can be found in my earlier blog post about the DAO.
Accordingly, the SEC has also found that issuers and others who offer or sell tokens that qualify as securities in the United States must register the offering and sale with the SEC or qualify for an exemption from registration. By not doing either, the SEC determined that Munchee’s ICO was in violation of the federal securities laws. Like in the DAO investigation, however, the SEC decided not to impose a penalty against Munchee, recognizing that Munchee stopped the ICO quickly, immediately returned the proceeds before issuing tokens, and cooperated with the investigation.
In response to the Munchee order, Stephanie Avakian, Co-Director of the SEC’s Enforcement Division stated that the SEC “will continue to scrutinize the market vigilantly for improper offerings that seek to sell securities to the general public without the required registration or exemption.” Because the answer to whether a particular token is a security depends on the facts, individuals and companies seeking to raise capital through an ICO or otherwise, should first speak with a securities attorney to ensure the offering complies with state and federal securities laws.