Given the crazy run cryptocurrencies like bitcoin, ether and litecoin have been on in the last week, it was only a matter of time before the Securities and Exchange Commission weighed in. Well, now it has in the form of an open letter from SEC Chairman Jay Clayton.
Clayton addresses his comments to both Main Street investors and financial services and market professionals that are selling the new financial products — and he has choice words for both.
A tl;dr of the statement yields three main principles. For investors, it’s buyer beware. For market professionals: coin offerings are securities. And for market makers: you may be in violation of U.S. securities laws if you’re not registered with the SEC and selling some of these securities.
For Main Street investors, Clayton notes that there are “substantially less investor protection” than in traditional securities markets and cautions that this lack of protection creates greater opportunities for fraud and market manipulation (which… yeah, of course… and it also means there’s less recourse for investors if and when things go badly).
The SEC hasn’t registered any coin offerings and it hasn’t approved any public offering for exchange-traded products that hold cryptocurrency, so investors should be careful of anyone who makes claims to the contrary, Clayton warns.
Ultimately, Clayton’s advice to investors can be boiled down to a very simple maxim: IF IT SOUNDS TOO GOOD TO BE TRUE, IT PROBABLY IS. Beyond that, any encouragement to “act now” or that there’s a guaranteed upside to the investment probably means that an investor shouldn’t and that there isn’t (and if you’re interested in seeing a list of questions Clayton proposes an investor ask before investing in a token sale, see the end of this piece).
For market professionals, Clayton underscored the opportunity for entrepreneurs that cryptocurrencies represent, but also emphasized that an offering is an offering is an offering.
Here’s the relevant passage:
… any such activity that involves an offering of securities must be accompanied by the important disclosures, processes and other investor protections that our securities laws require. A change in the structure of a securities offering does not change the fundamental point that when a security is being offered, our securities laws must be followed. Said another way, replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.
I’m going to reiterate that, because the commissioner does. If a coin offering looks like a security, and floats like a security, then don’t be surprised if the SEC treats it like a security.
“Merely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security,” Clayton writes. “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.”
The effect of this statement on the market should be profound. While it’s probably true that the crypto community knew this was coming, it’s the most starkly worded language I’ve seen about the way the SEC intends to treat coin offerings or “token” sales. Indeed, Clayton indicates that he doesn’t recognize a difference.
Beyond the market professionals, Clayton puts securities lawyers, accountants and consultants on notice that they need “to be guided by the principal motivation for our registration, offering process and disclosure requirements: investor protection and, in particular, the protection of our Main Street investors.”
Finally, it seems like Clayton and the SEC have found one red line where consumer interests are not to be crossed, and that’s in the crypto space. He ends with a warning to the shills, hucksters, con-men, snake oil salesman and celebrities that have been pitching coin offerings as way to get rich.
“Selling securities generally requires a license, and experience shows that excessive touting in thinly traded and volatile markets can be an indicator of ‘scalping,’ ‘pump and dump’ and other manipulations and frauds,” Clayton writes. “Similarly, I also caution those who operate systems and platforms that effect or facilitate transactions in these products that they may be operating unregistered exchanges or broker-dealers that are in violation of the Securities Exchange Act of 1934.”
The tough talk doesn’t end there. “While there are cryptocurrencies that do not appear to be securities, simply calling something a ‘currency’ or a currency-based product does not mean that it is not a security,” Clayton writes. “Before launching a cryptocurrency or a product with its value tied to one or more cryptocurrencies, its promoters must either (1) be able to demonstrate that the currency or product is not a security or (2) comply with applicable registration and other requirements under our securities laws.”
Sample Questions for Investors Considering a Cryptocurrency or ICO Investment Opportunity
- Who exactly am I contracting with?
- Who is issuing and sponsoring the product, what are their backgrounds, and have they provided a full and complete description of the product? Do they have a clear written business plan that I understand?
- Who is promoting or marketing the product, what are their backgrounds, and are they licensed to sell the product? Have they been paid to promote the product?
- Where is the enterprise located?
- Where is my money going and what will be it be used for? Is my money going to be used to “cash out” others?
- What specific rights come with my investment?
- Are there financial statements? If so, are they audited, and by whom?
- Is there trading data? If so, is there some way to verify it?
- How, when, and at what cost can I sell my investment? For example, do I have a right to give the token or coin back to the company or to receive a refund? Can I resell the coin or token, and if so, are there any limitations on my ability to resell?
- If a digital wallet is involved, what happens if I lose the key? Will I still have access to my investment?
- If a blockchain is used, is the blockchain open and public? Has the code been published, and has there been an independent cybersecurity audit?
- Has the offering been structured to comply with the securities laws and, if not, what implications will that have for the stability of the enterprise and the value of my investment?
- What legal protections may or may not be available in the event of fraud, a hack, malware, or a downturn in business prospects? Who will be responsible for refunding my investment if something goes wrong?
- If I do have legal rights, can I effectively enforce them and will there be adequate funds to compensate me if my rights are violated?
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