Is an ICO an investment? The SEC clarifies – kind of
From the get-go, those who promote cryptocurrencies have struggled with these virtual entities being both tokens that can (ostensibly) be used to buy things, like currency, and an investment opportunity, like a security. This dual identity has left regulators and investors alike scrambling to manage this emerging financial force. Among the most vexing issues: When people buy crypto coins or tokens through an Initial Coin Offering (or ICO) are they truly buying an alternative currency or merely investing in the company that will issue them?
The SEC recently weighed in with a timely set of guidelines to help address this question. The agency also issued what’s known a non-action order, to inform a would-be ICO issuer that they could proceed with their offering without SEC oversight.
The moves have generally been welcomed for bringing order to a new and volatile marketplace, and have also provided helpful signals into how regulators are now approaching the oversight of cryptocurrency. As NOW CFO partner Mike Rodriguez says, “the guidelines are definitely helpful,” and begin to take the ICO marketplace from “something like the Wild West into…a framework for traditional legal compliance.”
First, some background. As with crime in the true Wild West of yore, securities regulators and others have been taking an increasing interest in ICOs, especially given such problematic launches as that for crypto financial services startup Centra Tech, whose deceptive ICO drew endorsements from celebrities, Floyd Mayweather and DJ Khaled. Concern and scrutiny only heightened when many coins plummeted in value over the past year or so, after the heady days of Bitcoin mania.
Here are some key takes that Rodriguez, who’s helped many companies navigate SEC compliance issues, and others see in the latest SEC moves:
- The functionality of the token is key to its status. The SEC guidelines list dozens of considerations that point towards, or away, from defining a coin as an investment contract, and thus subject to registration as a security. But two related considerations seem to stand out.The first is, essentially, how finished is the asset—the coin—and the ledger network that will be used to share it and verify ownership of the coin. The more work remains to be done before coin and network are fully functional, and the more that will require the work of others, like those who are launching the token, the more likely the SEC is to consider the purchase to be an investment that requires registration.The other side of the coin, if you will, is whether holders of the asset are, in the words of the SEC guidelines, ”immediately able to use it for its intended functionality on the network, particularly where there are built-in incentives to encourage such use.”Here the converse applies: The more readily a coin can be used, the less likely that its purchase constitutes an investment contract requiring SEC registration. If the asset is a usable and tangible thing, more than a glint in the eye of its developers, it becomes further from the regulatory territory of a speculative and uncertain status. In other words, the less it is merely a speculative investment.
- The no-action letter is a reassurance to some. The letter, to the Florida-based TurnKey Jet Inc, essentially greenlit a plan by the air carrier to issue tokens that are usable for air-charter flights with the company, without requiring the assets to be registered as securities. To some observers, though, the restrictions the SEC set out in the ruling are hardly encouraging to the freewheeling ICO community; for example, the TurnKey tokens must be non-transferable, the SEC stipulated.
However, to others such as Rodriguez, the letter was a positive step. “It’s a real step forward from…before this came out, where [this kind of offering] was just a total up-in-the-air question—so to speak.”.To others who fear the SEC’s entrance into regulating ICOs will serve only to squelch entrepreneurial spirit, the no-action letter provides early reassurance that the commission will take a balanced and measured approach.
Proceed with caution, still. The SEC guidelines are just that, Rodriguez points out, guidelines “that lack the force of law.” As the SEC considers next steps, he says, ICOs remain “an evolving area, and there’s uncertainty within it.” The stakes involved include such problems as running afoul of the Securities Acts of 1933 and 1934 in offering unregistered securities. And a lot of the work involved, he says, is in “an area between legal issues and accounting issues,” where having advisors in both disciplines with deep experience with SEC matters will be helpful and prudent.