Initial coin offerings (ICOs) are becoming increasingly more common around the world as a method of raising funds. In exchange, a purchaser receives a digital coin or token, many of which can be traded on exchanges for other cryptocurrencies. A number of ICOs have now occurred in Australia.
We previously wrote about the regulatory challenges facing governments worldwide in respect of blockchain technology and cryptocurrencies, including the information sheet issued by ASIC in respect of ICOs.
The ASIC information sheet notes that certain requirements of the Corporations Act could apply to an ICO, depending upon such things as how the ICO is structured and operated, and the rights attached to the coin or token offered through the ICO.
The Securities and Exchange Commission of the USA (SEC) has very recently taken action against ICOs in circumstances where it considered the ICO had not complied with applicable legislation. Given the comments issued by ASIC, the SEC action serves as an example of how regulators can approach an ICO from a regulatory perspective.
PlexCoin is a cryptocurrency based on the Ethereum structure. Between August 2017 and early December 2017) funds were raised by way of an ICO, in exchange for PlexCoin tokens. The PlexCoin ICO was made using statements posted on the internet and distributed throughout the world.
In early December 2017, the SEC filed a complaint in the United States District Court seeking various relief. This included freezing the assets of entities related to the operation, requiring the defendants to return funds and assets they had moved outside of the USA and requiring the defendants to provide verified accountings of invested proceeds.
The SEC alleged in the complaint (amongst other things) that:
- approximately US$15 million was obtained through a fraudulent and unregistered offer of sale of securities called “PlexCoin” or “PlexCoin tokens” by way of an ICO. Through that period, approximately 81 million PlexCoin tokens were sold;
- there had been materially false and misleading statements made by the parties involved in the ICO, including promises that investors would obtain returns of 1,354% in under 29 days;
- the ICO for the PlexCoin Tokens was an illegal offering of securities in the USA because there was no registration statement filed or in effect during its offer and sale, and no applicable exemption from registration;
- the ICO occurred despite the Quebec Financial Markets Administrative Tribunal issuing an injunction in July 2017, directing various parties associated with PlexCoin from engaging in the unregistered offering of PlexCoin tokens; and
- the defendants had misappropriated, or attempted to misappropriate, at least US$200,000.00 of the funds raised in the ICO on “extravagant personal expenditures”.
The SEC press release, issued shortly after the complaint, reported that the SEC was successful in obtaining an emergency court order to freeze the assets of Plexcorps and certain related individuals. These charges were the first filed by the SEC’s new cyber unit, which focusses on misconduct involving distributed ledger technology and ICOs, amongst other things.
Munchee Inc (Munchee) is a California business that created an iPhone app for people to review restaurant meals. In October and November 2017, Munchee offered and then sold digital tokens (MUN token or MUN) by way of an ICO, in order to raise about US$15 million in capital.
Interestingly, the white paper issued by Munchee stated that “as currently designed, the sale of MUN utility tokens does not pose a significant risk of implicating federal securities laws”.
Despite that statement, the SEC took the view that the MUN tokens were securities pursuant to the Securities Act and that Munchee violated various sections of the Securities Act by offering and selling securities without having a registration statement filed or in effect with the SEC, or qualifying for exemption from registration with the SEC.
Under the relevant provision of the Securities Act, a security includes an “investment contract”. In turn, an investment contract is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.
In considering whether there was such a reasonable expectation of profits being derived, the SEC reviewed various information associated with the ICO, including blog posts made by Munchee, a podcast by the founder of Munchee and public statements made by Munchee, including on Facebook.
Prior to proceedings being instituted by the SEC, Munchee made an offer of settlement to the SEC, which was accepted. Orders were then made requiring Munchee to cease and desist from committing or causing any violations or future violations of certain provisions of the Securities Act.
Ultimately, the effect of the orders was that Munchee shut down its ICO, did not deliver any tokens to purchasers and returned the proceeds it had received to date.
Other litigation consequences
In addition to regulatory action, an ill-prepared ICO could result in other litigation consequences, including where:
- misleading, deceptive or false statements are made in the ICO or elsewhere associated with the ICO. This could lead to purchasers of the token commencing proceedings against the issuing entity; and
- there has been a breach of contract (for example, where a return on investment is written into the token issuing agreement). This will of course depend upon the terms of any agreement entered into between the issuing entity and the purchaser.
The above SEC decisions provide concrete examples as to regulatory action which can be taken where an ICO does not comply with relevant legislation. If you are considering an ICO, you should obtain advice about whether or not there are obligations under the Corporations Act or the general law in Australia which may apply to an ICO or token event.