Home » Initial Coin Offering

Category: Initial Coin Offering

SEC Says that ICO is Not a Securities Offering


The staff of the SEC’s Division of Corporation Finance has issued no-action relief that allows an initial coin offering without registration.  The no-action relief relies on an opinion of counsel that the underlying digital tokens are not securities as well as several other conditions including (i) the sponsor will not further develop the platform, (ii) the tokens will be immediately useable and functional, and (iii) the tokens are not marketed in a manner that emphasizes their potential for increased market value.  In a companion release, the SEC Strategic Hub for Innovation and Financial Technology (FinHub) issued guidance about how to determine if an ICO is an offering of securities under the applicable Howey test.  FinHub relies heavily on whether the sponsor of the network will engage in further development of the network or digital asset so as to generate increased market value for investors. 

Up until now, the SEC has taken the position that ICOs are securities offerings, subject to the Securities Act’s registration and disclosure requirements.  This no-action letter and companion guidance suggest that the SEC may back off its aggressive position and allow the digital token world to evolve organically.  What is unclear is whether any ICO sponsor should go forward without a no-action letter.

Self-Reporting ICO Forced to Offer Rescission to All Investors

The sponsor of an initial coin offering agreed to offer full rescission of proceeds raised in order to settle SEC charges that the firm engaged in an unregistered securities offering.  The sponsor raised $12.7 Million by issuing digital tokens in exchange for Ether as part of its efforts to raise funds to further develop its internet security product.  The tokens would serve as currency for a peer-to-peer network that would allow participants to access additional bandwidth in the event of a cyber-attack.  As part of its marketing, principals suggested that the value of the tokens should rise as the network expanded.  The SEC maintains that this “reasonable expectation of a future profit” satisfied the Howey test and that, therefore, the tokens were “securities” and the offering constituted an unregistered securities offering.  The SEC did not impose a civil penalty because the firm self-reported. 

We don’t think that the SEC has a slam-dunk case that ICOs are securities offerings.  In fact, some courts have opined that the SEC must specifically prove that each ICO is in fact a securities offering.  Until the courts offer some specific guidance, ICO sponsors should observe the securities laws to avoid a crippling enforcement action. 

Federal Court Rules that the SEC Must Prove that Digital Tokens are Securities

A federal judge has ruled that an initial coin offering may not constitute an offering of securities.  In rejecting the SEC’s request for a preliminary injunction against an ICO, Judge Gonzalo Curiel of the Southern District of California, opined that the SEC failed to present sufficient facts to satisfy the Howey test requiring an investment of money in a common enterprise with an expectation of profit produced by the efforts of others.  Faced with conflicting interpretations of how the ICO operated, the Court denied the preliminary injunction because of genuine disputes about material facts.

The significance of this decision is that a court is requiring the SEC to factually prove the three prongs of the Howey test rather than simply accept the SEC’s position that digital tokens are securities.  If the SEC fails to prove its case and digital tokens are not securities, the SEC will not have the legal authority to regulate ICOs. 

SEC Fines Two Initial Coin Offerings

The SEC ordered two initial coin offerings to offer investors rescission and pay a $250,000 fine for failing to register the offerings under the securities laws. These cases represent the first time that the SEC has imposed civil penalties solely for ICO securities offering registration violations.  One of the respondents raised $15 million by selling digital tokens intended to create a new digital coin ecosystem related to advertising and mobile phones.  The other respondent raised $12 Million to create a blockchain technology for the emerging cannabis industry.    The SEC maintains that the digital tokens are “securities” under the Howey test and, therefore, the offerings violated the registration requirements of the 1933 and 1934 Acts.  Both respondents undertook to register the offerings.

Given the SEC’s concerns about disclosure and compliance for ICOs, it will be interesting to see the extent of disclosure required in the promised registration statements.