I have been warning everyone that ICO-issued tokens (even if legally issued)
can’t be traded or used as a cryptocurrency, because as securities they must only be traded on regulated exchanges.
If the regulators were to allow ICO-issued tokens to trade freely (i.e. as a cryptocurrency), then they will have lost control over rampant, fraudulent speculative tragedy-of-the-commons mania.
Thus
the SAFTs that were sold in the Filecoin ICO encumber the Filecoin tokes as securities. Thus the Filecoin tokens are useless and can’t be actually used decentralized (unless hypothetically the common enterprise ceases as explained below).
Quoted from the 1933 Securities Act:
Any security given or delivered with, or as a bonus on account of, any purchase of securities or any other thing, shall be conclusively presumed to constitute a part of the subject of such purchase and to have been offered and sold for value. The issue or transfer of a right or privilege, when originally issued or transferred with a security, giving the holder of such security the right to convert such security into another security of the same issuer or of another person, or giving a right to subscribe to another security of the same issuer or of another person, which right cannot be exercised until some future date, shall not be deemed to be an offer or sale of such other security; but the issue or transfer of such other security upon the exercise of such right of conversion or subscription shall be deemed a sale of such other security.
Here are the narly details from an attorney:
No problem, right?
Not quite.
The answer to this question is a tiny bit more complicated and invokes a genuine piece of regulatory uncertainty.
The question here is whether a token issued pursuant to the terms of a security/investment contract (i.e. the SAFT) is itself also an investment contract. (Which, to this week’s SAFT offering’s credit, is briefly acknowledged in the PPM).
This question currently has no answer. If our hypothetical generic token isn’t a security, a lot of problems go away from a securities law perspective. But if it *is,* token issuance – SAFT or no SAFT – gets complicated, and fast.
There are two rules which are involved here. The first is Rule 230.502(d)(vii),which states
(d) Limitations on resale. Except as provided in §230.504(b)(1), securities acquired in a transaction under Regulation D shall have the status of securities acquired in a transaction under section 4(a)(2) of the Act and cannot be resold without registration under the Act or an exemption therefrom. [etc.]
And the second, to which the SEC made reference in its DAO paper as well, is Section 5 of the Securities Act, which states
Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly
(1) to make any use of any means or instruments of transportation or communication in interstate commerce [note: including the Interweb] or of the mails to sell such security through the use or medium of any prospectus or otherwise [note: presumably this encompasses half-baked crypto whitepapers], or
(2) to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for sale or for delivery after sale.
These are non-trivial continuing compliance obligations which are of fundamental relevance for cryptocurrencies – keeping in mind that a blockchain is traditionally the back-end of a fully automatic system designed to facilitate the instantaneous peer-to-peer transfer of digital property (meaning it’s likely to be classed as “interstate commerce”).
(Edit: with
the SAFT whitepaper now released, some of my former comments below may be inappropriate)
Damn right the SAFT is an investment contract where the expectation-of-profit is on the Filecoin tokens that will be issued to SAFT holders.
The Filecoin offering might be a legalese attempt to cheat. I’ve read this isn’t the first time that AngelList got themselves in trouble with the SEC.
Y Combinator’s SAFE concept (on which SAFT was modeled) doesn’t issue the participants some non-security. The SAFT is an attempt fool investors into thinking that it is on the same legal footing as the SAFE, but it is not.
AngelList can get away with this because they sold only to accredited investors and they buried a caveat in their prospectus, but the Filecoin tokens will never be legal to sell to investors decentralized until they’re registered (with sufficiently
holding period of at least 3 years before resold the first time), or hypothetically until those tokens stop being securities because there is no longer an investment contract under the Howey test, which could be when the investors no longer rely on a (pooled if “horizontal commonality” is the assumed definition of a) common enterprise for their profit expectation or presumably in the cases where the tokens are spent on bona fide goods or services rather than sold to an investor (but the same tokens in theory become securities again if sold to an investor where the investors’ profit expectation relies on a said common enterprise).
In particular, Benet drew a distinction between offering a coin for the purposes of raising money and using it as a tool for running a useful service.
My analysis about “use value” tokens being irrelevant to the issues that the Howey Test looks at, agrees with the attorney I am quoting here.
It doesn’t matter that the SAFTs can be speculated on and that the separate Filecoin tokens have some utility other than as speculations, the Howey Test only requires that the investors have an expectation-of-profit in a common enterprise managed by the others (typically the issuer), and the security is the investment contract certificate that records who receives the gains. Any obfuscations which attempt to circumvent the intent of the law, which is that securities must always be registered and trade on registered examples, are invalid under the Howey Test. There is no way to convert a security into a non-security (except as aforementioned the common enterprise ceases), because that would circumvent the entire point of the law. The investors are not investing in SAFTs but in the Filecoin tokens they receive for the SAFTs. Without the Filecoin tokens, the SAFTs are worthless. The Howey Test states it will always look at the economic reality and ignore any tricks that attempt to obfuscate the economic reality.
It is difficult to divorce the money and exchange component from “utility tokens,” as app-coins are sometimes called, particularly in the context of a speculative ICO where the token allocation is pre-sold to persons who could not possibly consume them all and are purchasing the coins with the expectation of profit on re-sale.
…
For this reason, my personal view is that most ICOs – even the “utility coins” – are unlikely to escape regulation by jurisdiction-appropriate rules regarding public offerings, financial promotions and unfair trade practices. I have held this view since 2014 but then again I’m pretty conservative.
If the SEC announces that AngelList’s prospectus is misleading and orders it to be refunded, that could have another big hit on expectations in our crypto ecosystem. More “bad news” is coming eventually.
If this happens, although the SEC will stay in the loop, the really exciting action will be in the domain of the tort lawyers and federal and state prosecutors working in tandem with the FTC. See, e.g., the recent case of Josh Garza and GAW Miners (which involved fraudulent misrepresentations relating in part to a cryptocurrency called Paycoin). Although in the civil enforcement action the SEC got a $12 million default judgment, the U.S. Attorney got a guilty plea for one good, old-fashioned count of wire fraud. No Securities Act required.
Note that if this interpretation is adopted, some state laws cast a much wider net to penalize participants than Section 5 of the Securities Act of 1933 does.
tl;dr
In the wake of the SEC’s paper last week, and at all points before it, the blockchain industry’s thinking has over-emphasized complying with regulations that govern the initial issuance of tokens, and has neglected to address the impact of all of the regulations that apply on a continuing basis.
Trading in ICO-issued tokens is encumbering YOU with potential long-tail legal woes that come at you from many different regulatory bodies, statutes, and nations. It is jurisdictional hell. Stay away from this!
I think that the next max cap can be COMSA ICO. Not just because I advertise it at my signature…
Promoting ICOs makes you an affiliate. Which means you have severe fines and even jail time awaiting you in the future.
You may be in a some 2nd or 3rd world country and think you are out-of-reach of such regulatory crackdown. But those G20 can still find a way to take your assets and arrest you. That is if you use an international wires, travel internationally, etc.. They may also in the future pressure your government to acquiesce to enforcement as the USA has achieved with FATCA worldwide.
EDIT: since writing this post, I have recently
analysed the securities implications in more detail.
Disclaimer: IANAL. This is not legal advice.
