A recent settled SEC enforcement action against an ICO issuer (the “Company”) and its promoter calls into question the viability of the “airdrop” model of distributing digital tokens to investors. In the ICO context, an “airdrop” generally refers to the widespread distribution of digital tokens to community members either for free or in exchange for performing menial tasks. Whether such a distribution model runs afoul of the federal securities laws has been the subject of much debate in recent months, and the SEC’s case provides additional insight into their analysis of the issue. While a narrow path for airdrops may remain, the case will significantly curtail their current use.

By way of background, the fundamental tenet of federal securities regulation in the United States is that every offer or sale of securities must be registered with the SEC or exempt from such registration. There is usually no exemption available when securities are distributed on a wide scale to large numbers of unsophisticated offerees. An “offer” is defined broadly under federal law as “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.” For many years, the SEC has taken the position that any publicity that may “contribute to conditioning the public mind or arousing public interest” in the offering can itself constitute an offer. Under certain circumstances, however, a bona fide gift of securities is not deemed to involve the offer or sale of those securities, and under this “no sale” theory the registration requirements of the federal securities laws do not apply to the purported gift.

In this case, the Company sought to raise $5 million through an ICO of proprietary tokens, purportedly to fund oil drilling in California. When the Company failed to raise any money in the ICO, it instead made an airdrop of tokens to third parties by means of a “bounty program” in exchange for online promotional and marketing services that targeted potential investors and directed them to the Company’s offering materials. The SEC quickly concluded that the tokens were securities under the analysis in its DAO Report. The SEC also alleged a series of materially false and misleading statements in the Company’s marketing documents. But perhaps of greatest interest to the crypto community is the SEC’s analysis of the Company’s so-called “bounty program.”

The SEC determined that the Company’s issuance of tokens under the bounty program constituted an offer and sale of securities because the Company provided tokens to investors in exchange for services designed to advance the Company’s economic interests and foster a trading market for its securities. According to the SEC, the lack of monetary consideration for “free” shares does not mean there was not a sale or offer for sale for purposes of the federal securities laws. Rather, a “gift” of a security is a “sale” for securities law purposes when the donor receives some real benefit, even if it does not involve the exchange of money. In this case, the Company received value in exchange for the bounty distributions, in the form of online marketing including the promotion of the ICO on blogs and other online forums. The Company also received value in the creation of a public trading market for its securities. Accordingly, the SEC determined that the Company issued tokens as part of the bounty program to generate interest in the ICO, which in turn benefited the Company. Thus, the SEC concluded that distribution of tokens that are securities in exchange for promotional services to advance an issuer’s economic objectives or create a public market for the securities constitute sales for purposes of the federal securities laws.

The recent case is reminiscent of the SEC’s enforcement actions against several internet companies that distributed “free stock” during the height of the dot-com craze 20 years ago. In what have become known as the “free stock” cases, investors were typically required to sign up with issuers’ websites and disclose personal information in order to obtain the “free” shares. Free stock recipients were also offered extra shares for soliciting additional investors or for linking their own websites to those of an issuer or purchasing services offered through an issuer. Due to these activities, the SEC likewise took the position that the issuers received value (and did not make a gift) by creating a public market for their shares, increasing their business prospects, creating publicity, increasing traffic to their websites and generating possible interest in future public offerings.