US SEC Cleans Up Ethereum ICOs Keeping Them Honest Classifying Them As Securities
With the boom of cryptocurrencies, many geeks have flocked to the virtual mining of Bitcoin and Ethereum. The boom in Ethereum mining recently was so massive that it was hard for gamers to find AMD Radeon graphics cards for gaming PCs because so many Ethereum speculators had gobbled up all the cards on the market. Even the co-founder of Ethereum, Charles Hoskinson, has said that cryptocurrency ICOs (initial coin offerings) are a "ticking time bomb."
Part of the issue with these ICOs, which often drawn large sums of money very quickly, according to Hoskinson is that they are unregulated and sidestep safeguards required in traditional securities trading. Brad Garlinghouse, the CEO of money-transfer firm Ripple, went so far as to say that he believed the SEC would eventually regulate cryptocurrencies by viewing them as securities. That prophetic vision has now come to pass with the SEC issuing a report this week specifically stating that "U.S. securities laws may apply to offers, sales, and trading of interests in virtual organizations."
The SEC makes it clear in the very first paragraph of the report that offers and sales of digital assets by virtual organizations are subject to federal securities law. The report states, "Such offers and sales, conducted by organizations using distributed ledger or blockchain technology, have been referred to, among other things, as 'Initial Coin Offerings' or 'Token Sales.' 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."
The SEC says that the tokens offered and sold by "The DAO" were securities and were subject to federal securities laws. That means that issuers of distributed ledger or blockchain technology-based securities have to register offers and sales of the securities unless a valid exemption applies. This also means that if a virtual organization participates in unregistered offerings could be liable for violations of securities laws. Companies that trade in securities are required to register to insure investors are sold investments that have all the required disclosures and are subject to regulatory scrutiny in an effort to protect the investors.
"The SEC is studying the effects of distributed ledger and other innovative technologies and encourages market participants to engage with us," said SEC Chairman Jay Clayton. "We seek to foster innovative and beneficial ways to raise capital, while ensuring – first and foremost – that investors and our markets are protected."
"Investors need the essential facts behind any investment opportunity so they can make fully informed decisions, and today's Report confirms that sponsors of offerings conducted through the use of distributed ledger or blockchain technology must comply with the securities laws," said William Hinman, Director of the Division of Corporation Finance.
The SEC report is the result of an investigation started by the Enforcement Division that was looking into whether The DAO and associated entities and individuals violated federal securities law by selling Tokens in exchange for Ether virtual currency. The report found that while The DAO was described as a crowdfunding contract, it did not meet the requirements for a Regulation Crowdfunding exemption because it was not a broker-dealer or a funding portal registered with the SEC.
"The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets," said Stephanie Avakian, Co-Director of the SEC's Enforcement Division.
The good news for those involved with The DAO is that the agency decided not to bring charges against the individuals. Instead, the SEC has chosen to caution the industry and participants in that market.The report states, "The federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology."