On January 22, 2018, Securities and Exchange Commission (SEC) chair Jay Clayton delivered remarks to the Securities Regulation Institute. He vehemently condemned market professionals who enabled token offerings (also referred to as ICOs) that fail to comply with SEC regulation. Clayton also made clear that the SEC is examining public companies that have pivoted toward blockchain or distributed ledger technology. One company that might have attracted the agency's attention is Eastman Kodak.
Token Offering Regulation
"My first message is simple and a bit stern," said Clayton. "Market professionals, especially gatekeepers, need to act responsibly and hold themselves to high standards. To be blunt, from what I have seen recently, particularly in the initial coin offering ('ICO') space, they can do better."
Invoking US securities laws and "80 plus years of practice," the chairman said that securities lawyers, accountants, underwriters, and dealers are expected to "bring expertise, judgment, and a healthy dose of skepticism to their work." He added, "Even when the issue presented is narrow, market professionals are relied upon to bring knowledge of the broad legal framework, accounting rules, and the markets to bear."
"Legal advice (or in the cases I will cite, the lack thereof) surrounding ICOs helps illustrate this point. Let me posit a few scenarios. First, and most disturbing to me, there are ICOs where the lawyers involved appear to be, on the one hand, assisting promoters in structuring offerings of products that have many of the key features of a securities offering, but call it an 'ICO,' which sounds pretty close to an 'IPO.' On the other hand, those lawyers claim the products are not securities, and the promoters proceed without compliance with the securities laws, which deprives investors of the substantive and procedural investor protection requirements of our securities laws."
In some cases, Clayton said, it appears that lawyers have "taken a step back from the key issues – including whether the 'coin' is a security and whether the offering qualifies for an exemption from registration – even in circumstances where registration would likely be warranted. These lawyers appear to provide the 'it depends' equivocal advice, rather than counseling their clients that the product they are promoting likely is a security," worried Clayton. "Their clients then proceed with the ICO without complying with the securities laws because those clients are willing to take the risk."
"With respect to these two scenarios, I have instructed the SEC staff to be on high alert for approaches to ICOs that may be contrary to the spirit of our securities laws and the professional obligations of the U.S. securities bar."
Clayton also singled out ICOs that lack professional advice altogether: "I recognize that in some ICOs there is no market professional involved. The SEC is undertaking significant efforts to educate the public that unregistered securities investments offered by unregistered promoters, with no securities lawyers or accountants on the scene, are, in a word, dangerous."
Mainstream Pivots To Blockchain Technology
Of the conventional market, Clayton expressed manifold concerns:
"I doubt anyone in this audience thinks it would be acceptable for a public company with no meaningful track record in pursuing the commercialization of distributed ledger or blockchain technology to (1) start to dabble in blockchain activities, (2) change its name to something like 'Blockchain-R-Us,' and (3) immediately offer securities, without providing adequate disclosure to Main Street investors about those changes and the risks involved."
The chair advised, "The SEC is looking closely at the disclosures of public companies that shift their business models to capitalize on the perceived promise of distributed ledger technology and whether the disclosures comply with the securities laws, particularly in the case of an offering."
In December 2017, Clayton published his views on cryptocurrency and the market for token offerings. He previously expressed concern about pump and dumps and insider trading carried out in connection with token offerings.
This past week, the SEC's director for the division of investment management issued a letter raising many, many questions about cryptocurrency-based financial products. As ETHNews previously reported, reverse mergers are another point of concern for the agency.