What Happens If I Don’t Register My ICO With the SEC?
More and more, companies and investors are considering initial coin offerings (ICOs) as a convenient way to raise capital or engage in investment opportunities. An ICO is the cryptocurrency industry’s equivalent to an initial public offering, or IPO. Usually, a company that wishes to raise money to create a new coin, application, or service uses an ICO to raise funds for the venture. Investors interested in the venture can buy into the offering and receive a new cryptocurrency token issued by the company. The company may use the token along with its product or service, or the token may simply represent a stake in the company or its project.
When a company wants to raise money through an ICO, it usually issues a whitepaper that outlines the proposed project, the goals of the project, how much capital is being sought, how many virtual tokens will be issued, and how long the ICO campaign will run. During the campaign, investors buy some of the project’s tokens with fiat currency, or in some cases another virtual currency. These tokens are much like the shares of a company that are sold to investors during an IPO. In general, if the funding requirements are met within the specified timeframe, the money raised in the ICO is used to pursue the stated goals of the venture.
There are significant distinctions between an ICO and an IPO. Most importantly, ICOs are not necessarily subject to the same regulations as IPOs. The Securities and Exchange Commission (SEC) generally does not directly oversee ICOs. Additionally, because of the decentralization and limited regulation, ICOs can be more dynamic in their terms of structure. Because they are less regulated, ICOs are more likely to be used by fraudsters and scam artists who prey on uninformed investors. Victims of ICO fraud face many challenges when attempting to recover funds lost due to fraud or incompetence in an ICO.
In some cases, however, the SEC considers ICOs to be essentially the same as IPOs, and therefore subject to SEC regulations. In general, an ICO is functionally the same as an IPO in the eyes of the SEC if the token raises money for an already existing business and does not operate independently of that business. Additionally, under the “Howey Test,” an ICO is a securities transaction if the party investing their money in the offering is led to expect profits on their investment solely from the efforts of the promoter or a third party.
Applying this test, the SEC has charged some companies that launched ICOs with violating U.S. securities laws. For example, in 2019 the SEC sued Kik Interactive Inc., a popular messaging service, for conducting a $100 million unregistered ICO. The SEC alleged that the tokens, which Kik sold to U.S. investors without registering the offer and sale with the SEC, were securities and were subject to U.S. securities laws. The SEC sought disgorgement of all profits earned on the ICO as well as a permanent injunction and civil penalties. In a similar case, the SEC halted an unregistered ICO by Telegram, another messaging service, that had raised more than $1.7 billion in investor funds.
The Securities Act of 1933 requires companies to register their securities with the SEC and disclose important financial information about the security to potential investors. In general, the registering company must provide the SEC with information about the company, its business, a description of the security being offered for sale, information about the company’s management, and financial statements for the company. As in the cases of Kik and Telegram, failing to properly register an ICO, when that ICO is considered a security, can result in disgorgement of profit, penalties, and restrictions on future fundraising activities. Furthermore, failing to register can expose the company to lawsuits brought by the investors, who may seek to rescind the purchase along with interest on the funds or money damages.
Not all ICOs are required to be registered with the SEC. The SEC looks to the facts of each ICO to determine whether, under the existing tests, it counts as a security. Additionally, even if an ICO meets the test for being a security, it may also qualify for an exemption from registration under SEC regulations. If the advertisements for an ICO tout the potential profits from investing in the token, the tokens are likely being sold as a security. Even so, if the company can structure the ICO so that it is more like purchasing gold, or any other commodity, it is more likely that the ICO is not technically a securities offering.
Companies that intend to conduct ICOs outside the SEC’s regulations should avoid giving purchasers any indication that they will receive a right, benefit, or expectation of profit from the ICO. It is also critical that the token have some utility outside of mere possession. They should provide the holder of the token with some benefit or service unrelated to the potential reward from any increased value to the token itself. For example, a company could sell a token that grants the holder access to storage, decentralized computing power, or the ability to contribute to the company’s project or venture. In fact, a company seeking to avoid SEC regulation may want to avoid calling its offer an ICO at all, as this term is linked to a security offering through an IPO and can imply that a security is being offered.
If you are considering whether your company should conduct an ICO, you should first consult an attorney who has experience in ICOs, cryptocurrencies, blockchain technology, and SEC regulations. An experienced SEC attorney can help you determine whether your ICO needs to be registered with the SEC and, if so, how to go about registering your ICO. You need to have reliable, up-to-date legal advice before conducting an ICO as the laws governing these offerings are complex and can change rapidly.
If you have been contacted by the SEC about an ICO that your company already performed, you should immediately contact an attorney who is experienced with SEC defense and the regulations on securities registration and ICOs. The penalties for failing to properly register an ICO with the SEC can result in millions of dollars in liability and can put the very existence of your company in jeopardy. An experienced SEC attorney can help you navigate any inquiries from the SEC and resolve your case as efficiently as possible.