As the new year starts, the world knows far more about initial coin offerings thanks largely to the consistent poking, prodding and warnings by the Securities and Exchange Commission into the crypto space last year. That trend will accelerate in 2018.
Ironically, the more regulators treat ICO tokens like securities, the more securities industry intermediaries will be drawn into this supposedly disintermediated space.
In 2018, the Securities and Exchange Commission will focus on those intermediaries — exchanges, brokers, advisors, attorneys, accountants and consultants. Be prepared.
As a possible indication of how regulators will be scrutinizing intermediaries, one need look no further than the Financial Industry Regulatory Authority’s 2018 Annual Regulatory and Examination Priorities Letter, which calls out ICOs as follows:
FINRA will closely monitor developments in this area, including the role firms and registered representatives may play in effecting transactions in such assets and ICOs. Where such assets are securities or where an ICO involves the offer and sale of securities, FINRA may review the mechanisms — for example, supervisory, compliance and operational infrastructure — firms have put in place to ensure compliance with relevant federal securities laws and regulations and FINRA rules.
Last July, the SEC informed the world that some tokens are securities and that the SEC has jurisdiction. July also brought a warning to ICO investors that “many fraudulent investment schemes involve unlicensed individuals or unregistered firms.”
September brought speeches about ICOs. The SEC’s chief accountant warned entities involved “token offering activities … to consider the necessary accounting, disclosure and reporting guidance.”
Later that month, SEC Chairman Jay Clayton tempered his general optimism about distributed ledger technology with the memorable statement, “it wouldn’t shock me” to see pump-and-dump schemes in the ICO space.
Also in September, the SEC announced the creation of a “new” Cyber Unit (that sounded much like the “CyberForce” announced in 1999) that would target “violations involving distributed ledger technology and initial coin offerings.”
The agency’s enforcement division brought a smattering of cases against ICO issuers last year. The first one, at the end of September, involved allegations of fraud about diamonds and real estate.
As summer turned to fall, the SEC turned up the heat, scolding “any celebrity or other individual who promotes a virtual token or coin that is a security” who fails to “disclose the nature, scope, and amount of compensation received in exchange for the promotion.”
In a statement that should have generated public outrage, the SEC asserted that “celebrities who endorse an investment often do not have sufficient expertise to ensure that the investment is appropriate and in compliance with federal securities laws.”
Just before Thanksgiving, Clayton again addressed the topic in a speech.
However, this time Clayton pivoted away from ICO issuers to “online platforms that list and trade virtual coins or tokens offered and sold” in ICOs. Those platforms, he said, are “susceptible to price manipulation and other fraudulent trading practices.”
December opened with the second ICO enforcement action alleging a scandale profound involving a resident of Quebec and tokens that would purportedly “yield a 1,354% profit in less than 29 days.”
Like the first enforcement action, the SEC’s case turned on straightforward fraud allegations about use of token sales proceeds and claims about the underlying enterprise.
The SEC closed out 2017 with two final ICO developments that telegraph where the agency is headed in 2018.
On Dec. 11, the SEC brought its first non-fraud, administrative cease and desist order, halting an ICO before it could get off the ground. Though the SEC did not allege any fraud and imposed no penalties, the SEC “intervened” after only $40,000 of the projected $15 million had been raised, and the issuer, a blockchain-based food review service, refunded all proceeds before delivering any tokens.
The order was notable for its speed, the absence of any fraud, and the fact that the issuer had concluded prior to the ICO that its tokens were not securities — a position the SEC flatly disagreed with. The SEC will most certainly replicate this blitzkrieg cease-and-desist model and apply it to other issuers.
Finally, in a Dec. 11 statement Clayton reiterated a coming change in focus from ICO issuers, who will continue receive attention, to non-issuer participants in the ICO space.
Specifically, Clayton observed that “[s]elling securities generally requires a license,” and he went on to “urge market professionals, including securities lawyers, accountants and consultants, to read closely the investigative report we released earlier this year.”