As increasing members of the public invest in cryptocurrencies and initial coin offerings, questions have arisen regarding the SEC’s role in regulating these markets. SEC Chairman Jay Clayton released a statement last month in an effort to share his views on the cryptocurrency and initial coin offering (“ICO”) markets. The first half of his statement was devoted to considerations for Main Street investors. SEC Chairman Clayton reserved the second portion of his statement for market professionals, through which he offered insight into his views regarding the potential classification of ICOs as securities, and regulatory responsibilities that apply to ICOs that are labeled as such. The final portion of the Chairman’s statement, provided a general discussion of cryptocurrencies and ICOs and how the SEC is working to protect investors as it relates to those markets. We will provide highlights from the second and third sections of the Chairman’s statement.
While ICOs allow entrepreneurs to raise capital for new projects, if an offering of securities is involved, the securities laws must be followed. The SEC issued an investigative 21(a) Report in 2017, in which the Commission evaluated a particular token within the context of various securities law principles. The Commission concluded that the token was a security under the federal securities laws. After the issuance of the report, various market professionals attempted to demonstrate that their proposed tokens or coins are not securities. Chairman Clayton subsequently explained that “tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law.” Consequently, the securities laws apply to those products and transactions.
Chairman Clayton advised market participants to determine whether securities laws apply to the promotion of the offer and sale of coins before touting them. Market participants should recall that a license is required to sell securities. In addition, those who operate systems and platforms that make transactions in these products possible may be operating exchanges or broker-dealers in violation of the Securities Exchange Act of 1934.
Given the absence of government regulation and oversight, cryptocurrencies open the door to potential illicit trading and financial transactions. Cryptocurrencies are within the SEC’s jurisdiction if they bear certain characteristics or are used in a certain manner. Whether a coin or token is a security that is regulated by the SEC, depends on the facts. It should be noted that the vast majority of initial coin offerings reviewed by the Chairman, “involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of [the] federal securities laws.” As a result, Chairman Clayton has instructed the SEC’s Division of Enforcement to patrol cryptocurrencies and ICOs and to recommend enforcement actions against those actors who conduct ICOs in violation of the securities laws.
Feel free to contact us for guidance on compliance issues related to cryptocurrencies and ICOs.