The U.S. Securities and Exchange Commission (SEC) recently filed a complaint in the United States District Court for the Eastern District of New York charging a businessman and two companies with defrauding investors in connection with two related initial coin offerings (ICOs). Among other things, the SEC alleges that the defendants have been selling unregistered securities, and that the digital tokens or coins do not actually exist.

According to the SEC, the ICOs were promoted as being backed by investments in real estate assets (the "Real Estate ICO") and diamonds (the "Diamond ICO"), respectively. The SEC alleged that the defendants subsequently converted the Real Estate ICO into the Diamond ICO, which the defendants reframed as an initial membership offering (IMO). The defendants distinguished their IMO from an ICO, stating that an "IMO is a brand new instrument of facilitating tokenized membership in a digital community or club."1 However, the SEC was not persuaded by this distinction.

In its complaint, the SEC defined an ICO as a "fundraising event in which an entity offers participants a unique 'coin' or 'token' in exchange for consideration."2 The Complaint further describes the typical process for implementing an ICO, which includes the issue of tokens on a blockchain or distributed ledger that "records all transactions in the network in theoretically unchangeable, digitally-recorded data packages called blocks."3 The tokens entitle their holders to certain rights related to assets or ventures underlying the ICO, such as rights to profits, a share of assets, rights to use certain services, or voting rights.

In its Complaint, the SEC alleged that the defendants had defrauded investors, in part, because no tokens or coins were actually issued and no real estate assets or diamonds were ever purchased. In each case, the SEC asserted that the ICOs were offerings of securities and that the ICOs involved general solicitations. Accordingly, the SEC alleged that the defendants had violated various securities laws, which included securities fraud and the unlawful offer and sale of securities.

While the facts of this case, if true, may be egregious, the SEC's case contains substantive analysis of ICOs and whether the offer and sale of the associated tokens or coins constitute securities. For those considering ICOs, careful analysis of this evolving area is warranted.