This is a guest contribution by Lionel Iruk. If you would like to submit a contribution please contact Bill Beatty for submission details. Thank you.
Cryptocurrencies and ICOs have been at the forefront of discussions over the past few months, particularly after the price of Bitcoin and certain other cryptocurrencies skyrocketed. The discussions, however, have been overshadowed by a number of myths and hearsay about their regulatory status and U.S. Securities and Exchange Commission (SEC) position on ICO and token sale. In this note, we shed light on 10 myths about regulatory control of tokens and cryptocurrencies in the United States. Please note that this article is for general information only and is not meant to be an investment advice and all persons need to consult experts or consider other sources before making any investment decisions.
Myth 1: The SEC has banned all ICOs
The SEC has the jurisdiction to act on initial coin offerings if they are made in U.S. territory, made by a U.S. entity or if any U.S. investor is involved in ICOs in any manner. The SEC has used its powers to act on certain ICOs which it feels have not complied with the securities legislation or have put forward false facts or commitments to receive investments. However, it has not banned ICOs and SEC Chair Jay Clayton stated on December 11, 2017, that the regulator is instead conducting investigation and acting against ICOs which it feels are in violation of the laws.
Myth 2: All tokens are securities
The tokens which are offered for sale through ICOs or token sales may be securities or a simple digital asset. The fact whether a token is a security depends on the characteristics of the token and the facts of the situation. While certain tokens may be deemed to be securities, others clearly have functions only limited to the software or online environment with which they are related. The SEC has clarified in the DAO Press Release that “Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.” More clarity on the fact that all token sales are not sale of securities can be found through this post.
Myth 3: Participating in a token sale or ICO is not possible in US
Participation in a token sale or ICO which is made in compliance with U.S. securities laws is possible for both main street and institutional investors. However, Clayton has asked the investors interested in ICO’s to seek answers to all questions and ‘apply good common sense.’ It might be pertinent to note here that certain ICO’s or token sales may be restricted to special classes of investors only, such as accredited investors, and individuals may not be able to take part in such opportunities. As a rule of thumb, read all sale documents, terms and conditions and fine print carefully and seek clarifications in case of any doubts.
Myth 4: The Munchee Order classifies all tokens as securities
A review of the Munchee Order clearly provides that the ‘MUN Tokens’ were deemed to be securities only because of the special circumstances behind the issuance of the tokens and the commitments which were made at the token sale. According to the order, the MUN Tokens were sold without a SEC registration as security and investors have a future expectation of profit to be derived from the entrepreneurial or managerial efforts of others. In other words, the entire business model was built on using the investor funds to create the platform and hence investors had an expectation of profits after it was created. This order does not mean that all tokens are securities and instead clarifies the parameters which the SEC deems essential for consideration of a token as a security.
Myth 5: The Plexcoin actions shows that cryptocurrencies are illegal
The Plexcoin filing by SEC only shows that the SEC is willing to act against all unregistered offerings which are not in compliance with U.S. securities laws. The SEC filings clearly show that Plexcoin made promises of huge gains for its investors through ‘false and misleading’ statements. The offerings by Plexcoin were also not in compliance with U.S. securities laws and were not registered. This led the SEC to act and protect the investors. The SEC has however not stated that cryptocurrencies themselves or holding or receiving them is illegal.
Myth 6: ICOs are not possible by US companies
ICOs can be made even by U.S. companies. However, they have to evaluate whether the token or coin that they are willing to sell is a security under U.S. laws and if it is a security they have to ensure that they register with the SEC. U.S. ICOs also have to ensure the coins or tokens that are offered only to eligible investors, if they are classified as securities. As is the rule with any ICO across the world, consultation with a qualified attorney is essential for a smooth ICO by a U.S. company.
Myth 7: The SEC has approved or registered certain initial coin offerings
On December 11, 2017, Clayton clarified that the SEC has not registered any ICO till that date. The SEC, however, has requested companies considering ICOs to evaluate if the tokens or coins that they offer are securities and register with the SEC and comply with U.S. securities laws if they are found to have characteristics similar to securities.
Myth 8: SEC and CFTC issue cryptocurrency exchange licenses
Cryptocurrency exchanges that presently operate in the U.S. operate under Money Services Business (MSBs) Licenses granted by individual U.S. states and also under New York BitLicense. They also register with the FINCEN as MSBs. The SEC or CFTC do not have any regulation to regulate such exchanges at the moment. However, this can change soon with the SEC chairman testifying before the Senate that he may be open to regulating such exchanges.
Myth 9: Registration as an MSB is always required to conduct an ICO in US
This is rather a grey area of law and not a complete myth or truth. Registration as a Money Services Business (MSB) may not always be mandatory to conduct an ICO in the U.S. The exact provision which might apply to a company which wishes to conduct an ICO is not yet clear as the FinCEN has conveyed contradictory messages through the Ripple Labs Settlement Agreement (‘Ripple Settlement’) and the Software and Investment Ruling. Till further clarity is not received on the subject, it is best to seek consultations with the FinCEN and your attorney before conducting an ICO and seek information on if you would need to register as an MSB.
Myth 10: Detailed KYC and AML compliance is only required for transactions above $3,000 and in case of lower transactions merely an online checkbox is sufficient
It is a myth that Anti-Money Laundering (AML) and Know Your Customer/Client (KYC) compliance is required for transactions above $3,000 only. In fact, Ripple was fined for not maintaining an appropriate AML program (see Ripple Settlement mentioned above). In fact, 31 C.F.R. §1022.210 requires each MSB to develop, implement and maintain an effective AML program. The $3,000 limit is also not relevant for most scenarios as 31 C.F.R. §1022.320(a)(2) requires you to report transactions which ‘involves or aggregates funds or other assets of at least $2,000’ meaning that multiple transactions which add up to the limit may also have to be reported. Additionally, unidentified sale may involve possible sanctions violation. As such, it is highly recommended that identification documents are obtained and verified for everyone taking part in token sales or ICOs to avoid potential violations and penalties.
Conclusion: As with all myths and half-truths, it’s always a good idea to do your research and surround yourself with qualified individuals you can rely on. With ICOs in 2018 breaking records never thought possible, it seems as though the ICO market is here to stay for the foreseeable future. While it is true that initial coin offerings have become one of the most powerful crowdfunding innovations of the decade, it is also true that with such great power comes great responsibility for ICO issuers to stay legally compliant.
So stay focused, stay informed, and enjoy the ride.
Lionel Iruk, is an Blockchain/ICO Legal Advisor having aided over 200+ token sales worldwide; he is principal attorney and manager at Empire Global Partners, PLLC and IRUKE LAW FIRM, PLLC and frequent legal contributor to CalvinAyre.com and CoinGeek. He has been involved in Blockchain and Crytpocurrency matters since late 2010, and international iGaming projects throughout the Continental United States, Europe and South East Asia since 2008. His practice focuses on international wealth management, corporate structures, Financial Technology/ Bitcoin Law, and issues affecting for profit and non-profit organizations and charitable foundations.
He can be contacted at firstname.lastname@example.org