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Author Topic: What Does the SEC Report Imply for the Crypto Community?  (Read 1246 times)
Cannabisdreams (OP)
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July 26, 2017, 04:12:11 AM
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I posted this elsewhere but think it more properly belongs here:

An analysis of the SEC Report, released on July 25, 2017, By a non-lawyer community member.

On, July 25, 2017, the United States Securities and Exchange Commission (SEC)released their investigative report regarding “The DAO” initial coin offering (ICO)which was launched in April, 2016, and was subsequently hacked during the ICO sale.  The most attention grabbing assertion in this report is that DAO Tokens were defined as securities, and are therefore subject to the laws and regulations of the SEC.  Furthermore, the report states that ICO issuers as well as investors are required to register with the SEC, unless an exemption applies.

What does this mean?  Should we all start dumping our ETH tokens on the nearest exchange and wipe our hard drives?  No, probably not. It is important during these fast moving and ever changing times to keep a clear head and examine the real world impact that this report will have on the average user and token issuer.  I will attempt to break down each section of the SEC’s report and provide you with a summary of their assertions and conclusions.  I am not an attorney, I am not a financial adviser, I am not giving anyone advice in relation to anything. My purpose is to increase community awareness and assist those who have trouble understanding the convoluted legal jargon. 

First, please understand that this is an investigative report, nothing more.  This is not a law nor is it a proposed law.  This is a legal opinion offered by a government agency.  While it may be very influential in developing future legal arguments and regulation enforcement in the United States, it is simply an opinion at this point.  Further clarification and modification through legal challenges will most certainly follow in the months and years to come.   

A .pdf of the SEC Investigation Report can be found here: https://www.sec.gov/litigation/investreport/34-81207.pdf

In section I, paragraph four, the SEC states as follows:

   “The investigation raised questions regarding the application of the U.S. federal securities laws to the offer and sale of DAO Tokens, including the threshold question whether DAO Tokens are securities. Based on the investigation, and under the facts presented, the Commission has determined that DAO Tokens are securities under the Securities Act of 1933.”

   The SEC is basing its determination that DAO tokens are securities on the following factors which I have listed numerically for ease of reference:
     1.   Foundational Principles of the Securities Laws Apply to Virtual Organizations or Capital Raising Entities Making Use of Distributed Ledger Technology
     2.   Those who Invested Money in The DAO
     3.   With a Reasonable Expectation of Profits
     4.   Derived from the Managerial Efforts of Others
            a.   The Efforts of Slock.it, Slock.it’s Co-Founders, and The DAO’s Curators Were Essential to the Enterprise
            b.   DAO Token Holders’ Voting Rights Were Limited

The first factor asserts that SEC laws apply to blockchain technology and virtual organizations because under the Securities and Exchange Act a security includes “an investment contract.” This argument certainly works for some currencies and assets as they are openly based on ‘smart contracts’ among other similar configurations.  Whether or not this would apply to all cryptocurrencies is debatable.  The SEC acknowledges in other areas of their report that these determinations should be taken on a case by case basis and include multiple factors.

The SEC’s second argument is that members of the DAO invested money.  In order to perfect an investment contract, there must be an exchange of money from investors. They assert that the ‘term’ money does not have to mean cash.  The SEC cites several cases where it was held that virtual currency, namely bitcoin, can be used to create an investment contract.  Conversely,it has not been established that simply investing in, or contributing to, a community project would be subject to this section.  There is room for argument on this premise that a specific cryptocurrency project may not fall under this section.

The third factor for determining whether a token or currency meets the definition of a security is that investors have a reasonable expectation of profits.  In the case of the DAO, there were numerous marketing campaigns, whitepapers, and forum posts promising continual returns on investment.  Not all crypto currencies are launched in this way and not all promise a return from monetary gains.  Based on this,community members may be able to tailor their projects in certain ways to negate this factor. 

Finally, the SEC asserts that securities are investment gains derived from the managerial efforts of others.  This is where things can get really interesting and tricky for other cryptocurrency projects.  The DAO was set up in a very centralized way.  As the SEC pointed out, the founders and ‘curators’ of the DAO were essential to its’ enterprise.  The voting rights of investors were limited at best, and just for show at worst.  When the DAO hack occurred, investors had no control or legal standing to resolve the issue themselves and had to turn to the founders and curators for a solution.  In this way, the DAO was certainly managing the enterprise with little to no input from investors. Projects that are truly decentralized, where voting and new implementations are community based or automated, could potentially avoid meeting this factor. 

In summary as to whether a crypto project is or is not a security, this report simply outlines the criteria they used to determine whether or not the DAO should be considered a security.  It offers guidelines for future actions and regulation but does not change existing law.  While there are likely to be upcoming challenges on this issue,the courts of law may not accept the SEC’s argument in its entirety.  For now, it is best to seek the advice of an attorney specializing in virtual assets and/or securities trading in regard to how this report may affect you and our projects in the future. 

I hope you found this information helpful.  I will be following up with an analysis of the exemptions allowed under the Securities and Exchanges Act and how those may or may not apply to cryptocurrency projects. 

Dated: July 25, 2017
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July 26, 2017, 05:11:39 AM
 #2

Excellent analysis, I am following this developing news as well and I'm intrigued. Cant say we didnt see this coming though  Undecided fortunately, it seems a lot of CEOs in the space have at least considered this scenario already, so this should disrupt the ecosphere as little as possible.


One thing you didnt address; the position of exchanges in all this. Given that these are now securities (this is a guidance, but I am sure that the SEC will enforce the registration requirement after a few months, its clearly illegal at this point), they will have to register as security exchanges, with a much, much higher level of KYC/AML than they currently practice. Like, they will require socials to trade the security designated tokens, or coins (I can think of a few coins with a profit sharing/dividend feature). Also, have to wonder how this will affect tokens backed by specie.

This will deter a lot of the investors that appreciate the privacy and speed of cryptocurrency trading from participating, and restrict those that arent qualified investors from participating in a lot of these ICOs/coins. Inversely, the diligence performed at SEC filing should deter the majority of bad actors/scammers from offering these, cleaning the space up overnight.

with that being said, regulation is going to slow everything down to a standstill. its gonna take a few months to get through the red tape; these arent going to pop up as frequently, and I dont think they will be as big anymore. not mad at that, they were centralizing certain cryptos by concentrating them into single entity wallets, rather than wide distribution. thats never good for a market, a natural one at least.

people will regret throwing ETH at these things after POS implements, by the way. Wink
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July 26, 2017, 02:51:42 PM
 #3

Here is a nice overview of various token rights and how recent SEC announcement can influence token economics:
https://medium.com/@StorifierCo/token-economy-4a38ad02a239
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July 27, 2017, 12:12:51 AM
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The SEC of all things probably just wants people to NOT CONTACT THEM over ICO's. It's like they've made a public warning that they will consider action if turd monkeys start barking up their tree and costing them money.

The reason for security laws doesn't hardly apply to the DAO. Frankly no one, despite the white paper, could take the credibility of the DAO to be at a level where people would carelessly over-extend themselves in participation. Now if Goldman Sachs ran the DAO or something like that as their "latest product" and it failed massively... you can only imagine how much the application of the 1933 law would be reality. They have long standing trust as an entity that people would literally burden or ruin themselves on their promises.

Frankly the SEC can't do much of anything about ICO's. The reason is that ICO vulnerability is what is in question. The SEC can't "regulate" "safe" ICO websites and contracts that have been the entire focus of questionableness and attacks. In no way shape or form can they do anything but tell people not to participate, or shut down US based launches while kindly asking non-US based launches to not let US citizens participate - all of which have work-arounds. They aren't around to return money to people based on bad investments, for what possible reason could someone actually think they'd be able to return cryptocurrency to people? WHAT? That's legit insanity to have a presumption like that. The SEC doesn't even want to offer a shoulder to cry on.

Besides the SEC and regulations are antithetical to the concept of cryptocurrencies. Think about it, the first iteration of why they should exist is to stop double spending. Why would they not continue down a similar path of being free from regulation with similarly minded concepts? We're already moving there as the tech evolves. Look forward to digital security, peer regulation, not the SEC jumping into a global issue. Imagine the challenge for the SEC to fund a cryptocurrency division...


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July 27, 2017, 03:51:53 AM
 #5

Ethereum have been existing before any ICO surfaced on the market. Despite this report on the position of SEC on ICO, we should not worry that much because most of these projects having ICOs are not actually based on USA. Yes, of course, SEC can try to influence or even impose their views on other countries but we should not be afraid of USA anymore as it is MORE TALK AND NO MORE TEETH. Just look at how USA has already been a laughingstock all over the globe (now don't just blame Trump for this as this has been going on for many years).

Though I also consider the fact that there is really a need to somehow regulate issuance of ICOs but not thru SEC but an independent body that can do the needed due diligence...principally to minimize scams in the ICO market. Yes, we have to admit it that wherever there is money involved you can be sure that scam artists can be attracted easily and these scammers can wreak havoc a very good industry. As to how best to implement some sort of industry self-regulation that can be something subject for more discussions and even debates.
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July 28, 2017, 12:39:25 AM
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Ethereum have been existing before any ICO surfaced on the market. Despite this report on the position of SEC on ICO, we should not worry that much because most of these projects having ICOs are not actually based on USA. Yes, of course, SEC can try to influence or even impose their views on other countries but we should not be afraid of USA anymore as it is MORE TALK AND NO MORE TEETH. Just look at how USA has already been a laughingstock all over the globe (now don't just blame Trump for this as this has been going on for many years).

Ouch bro, that stung, LMFAO Grin

Quote
Though I also consider the fact that there is really a need to somehow regulate issuance of ICOs but not thru SEC but an independent body that can do the needed due diligence...principally to minimize scams in the ICO market. Yes, we have to admit it that wherever there is money involved you can be sure that scam artists can be attracted easily and these scammers can wreak havoc a very good industry. As to how best to implement some sort of industry self-regulation that can be something subject for more discussions and even debates.

well, because of the globally long arms of the SEC, even if you are stationed outside of the country, you have a duty to make sure no American investors can participate in your project if its not registered to an official accreditation body. so, this may make non American ICOs raise KYC requirements, to at least know the region the investor/user is coming from for liability reasons. i see this playing out as you will need to start registering with the ICO before you can invest, so they know yo came from an approved region, and your arent trying to launder money. but to be honest, these things were too unregulated to begin with.

i agree the sec is claiming a wide jurisdiction in this, but for the good of the entire ecosystem. these are financial products, and unfortunately there are rules in place way before bitcoin, for financial products. it takes away the fun, I know, but this is how we will make the mainstream. by going legit.
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July 28, 2017, 07:04:37 PM
 #7

The legal situation is so nebulous that it seems like you have to hire a law firm before doing an ICO.
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July 30, 2017, 11:25:40 PM
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This is indeed a great summary. I would add only that the language inferred that the SEC's was heavily fact specific and inured in almost its entirety to this particular token. Thus, my opinion is that it wasn't as sweeping an opinion as some have assumed. The SEC generally doesnt promulgate in this manner. One thought for an ICO would be to seek a Letter Ruling regarding that ICO from the SEC, which may, repeat may, ultimately give guidance on a broader spectrum of ICOs versus the one in question
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July 31, 2017, 08:56:04 PM
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The SEC of all things probably just wants people to NOT CONTACT THEM over ICO's. It's like they've made a public warning that they will consider action if turd monkeys start barking up their tree and costing them money.

and we get people that want to test the shit immediately:
http://benja.co/blog/2017/7/31/release-benjacoin-ico-event-a-pre-order-not-fundraise

Quote
SAN FRANCISCO, CA - Benja, the merchandise ad network, shared a letter to the U.S. Securities and Exchange Commission (SEC) Division of Corporate Finance as part of its continued mission to work with the SEC ahead of its Initial Coin Offering event.

The letter offers details of the benjaCoin offering, purpose, and goals. It provides documentation to support the fact that the sale of benjaCoin is a pre-order of future Benja inventory, and that the token is not a security in any way.

"We were thrilled with the response to my post in Hacker Noon last week (The SEC Called About Our ICO, I Answered). Near the end of the post, I promised to submit a letter to the SEC that would document, in detail, what steps we're taking to provide clarity about the purpose of benjaCoin.

*facepalm*

I think the SEC would allow the ICOs already in place, to at least finish. If you already planned and scheduled, you are most likely fine. Otherwise, they would have sent cease and desist letters instead of making a guidance. You figure they would only be able to enforce the rules against companies that offer these after the announcement, so essentially from now, people should be careful with starting these. We have been warned, its fair game now.

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July 31, 2017, 09:05:07 PM
 #10

Yes, you would think the pro-lifers would be more up in arms about Planned ParentHood SEC killing babies.

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