U.S. Securities and Exchange Commission (SEC) Chairman Jay Clayton issued a public statement on cryptocurrencies and initial coin offerings (ICOs), providing blockchain startups and ICO investors alike with the most in-depth look yet into the SEC’s stance on this nascent fundraising model — as well as whether utility token ICOs are subject to SEC regulation.
It’s a lengthy statement, and all market participants should read it in full, whether they intend to engage in ICOs or not. Nevertheless, here are the highlights.
Chairman Clayton was careful to state that although the SEC is concerned about ICOs, he believes the fundraising model is a promising way for startups to raise development capital.
“I believe that initial coin offerings – whether they represent offerings of securities or not – can be effective ways for entrepreneurs and others to raise funding, including for innovative projects,” he said.
Similarly, he stated that the technology used to power cryptocurrencies and ICOs could prove to be a disruptive force in the financial industry, potentially presenting investors on both Wall Street and Main Street with “promising investment opportunities”.
“The technology on which cryptocurrencies and ICOs are based may prove to be disruptive, transformative and efficiency enhancing. I am confident that developments in fintech will help facilitate capital formation and provide promising investment opportunities for institutional and Main Street investors alike,” Clayton said.
Nevertheless, this positive outlook does not mean the SEC is going to turn a blind eye to the ICO marketplace. He stated that the SEC is very concerned about the lack of investor protection, as well as increased prevalence of fraud and market manipulation.
“A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation,” he said.
Notably, he stated that most token sales of which he is aware — including utility token ICOs — fall under the purview of securities registration requirements, even though no token sale has registered with the SEC as a securities offering.
“By and large, the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws,” he said.
However, perhaps just as notably, he did not say that all ICOs are securities offerings, indicating that there is a framework through which true utility tokens — not securities wrapped with a utility token ICO label — could raise money through unregulated ICOs.
He gave the illustration of a utility token ICO used to bootstrap a book-of-the-month club as an example of a valid example of a token sale that would not constitute a securities offering.
“For example, a token that represents a participation interest in a book-of-the-month club may not implicate our securities laws, and may well be an efficient way for the club’s operators to fund the future acquisition of books and facilitate the distribution of those books to token holders. In contrast, many token offerings appear to have gone beyond this construct and are more analogous to interests in a yet-to-be-built publishing house with the authors, books and distribution networks all to come,” he said.
Finally, Mr. Clayton indicated that the SEC’s enforcement division is going to continue to ramp up enforcement of noncompliant ICOs.
“I have asked the SEC’s Division of Enforcement to continue to police this area vigorously and recommend enforcement actions against those that conduct initial coin offerings in violation of the federal securities laws,” he said.
This is not surprising. As CCN reported, one of the SEC’s new Cyber Unit’s chief mandates is to police ICOs, and just this month the SEC has revealed that the task force has intervened against two such ICOs. The commission filed a fraud suit against the organizers of the PlexCoin ICO — and one of its operators was thrown in jail. The SEC also halted the Munchee ICO, although it did not take further action against the startup’s operators other than requiring them to return the funds they had already raised.