The list of cases involving initial coin offerings (ICOs) continues to grow. The Securities and Exchange Commission (SEC) recently charged the founder (the "Founder") and Chief Operating Officer (COO, and, together with the Founder, the "Defendants") of a Delaware corporation (the "Company") with conducting a securities offering without registering with the SEC, allegedly in an attempt to deceive and entice investors to participate in the ICO, along with other criminal charges. The U.S. Attorney's Office for the Southern District of New York also announced that it is independently pursuing criminal charges against the Defendants.1 Although the U.S. Attorney's office has brought criminal charges, the underlying issue remains the same as that in the SEC's action, and this case highlights the various serious potential exposure risks for ICOs that run afoul of the securities laws.

Background of the Company and the Initial Coin Offering

The Defendants worked together to brainstorm, create, and ultimately launch the Company's ICO, beginning with a "pre-sale" of the Company's tokens in July and August 2017. Shortly thereafter, an "official" sale followed that ran through September and October 2017.2 To accompany the ICO, the Company released an initial white paper to explain the benefits of the token offering, how the tokens may be used, and the terms and conditions of their use. Over time, the Company released several subsequent white papers to further promote the Company and entice more investors into participating in the ICO. According to one of the Company's white papers, the Company "combine[d] both fiat and digital assets into one product," allowing token holders to "spend their digital currencies in real time without any transactions fees . . . leaving only a market exchange rate."3 The Company further claimed that it had a partnership with credit card merchants, including MasterCard, Visa, and The Bancorp, that "allowed users to exchange, withdraw, or spend cryptoassets in the U.S. and all over the world in real time, with zero fees and no exchange rate."4 The Company's product line included a Company "Card" and a Company "Wallet" that could be used in point-of-sale transactions.5

The Company also promoted the ICO in press releases through third parties such as Bitcoin.com, claiming that the Company token is "truly a ground floor opportunity," and even approached celebrities to promote the ICO on their social media accounts.6 These celebrities included boxing legend Floyd Mayweather and music producer DJ Khaled, neither of whom was named in the SEC complaint; they have declined to comment on the SEC's and the U.S. Attorney's investigations.

The Alleged Wrongdoing

Among its claims, the SEC alleges that the Defendants violated Section 5 of the Securities Act of 1933, as amended (the "Securities Act"), by selling unregistered securities.7 The SEC's allegations in the Complaint include certain interesting items. In particular, the SEC specifically highlighted that this ICO occurred "after the Commission's DAO Report of Investigation, which warned the industry that digital securities can be, and often are, securities."8 Interestingly, in its Complaint, the SEC chose not to include an analysis of the Company's tokens under the Howey test,9 declaring that investments offered during the ICO were "securities" within the meaning of Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Securities Exchange Act of 1934, as amended.10

The charges against the Defendants exceed merely failing to register their ICO. The Defendants also purportedly made several false and misleading statements and omissions in order to promote the ICO and the Company's products. These included allegedly falsely stating that they had partnerships with credit card merchants, purportedly fabricating descriptions of the Company's key officials, and falsely touting that investors would receive an 0.8% revenue share through the Company's "partnership" with credit card companies.

Takeaways

Although the allegations against the Defendants go beyond registration violations and include allegations of fraud, there are key takeaways for legitimate ICO issuers and participants in ICOs in this action. The Complaint's explicit reference to the launch of the Company's ICO after the SEC's DAO Report of Investigation creates a demarcation line for market participants and practitioners—sponsors of ICOs are on notice that tokens may be deemed "securities" by the SEC.11 In fact, the SEC deemed it unnecessary to even apply the Howey test to the egregious facts of this case, which, if true, may explain in part the SEC's short-form analysis. It also is a key reminder that statements made within offering documents and public statements must be accurate.