There is a buzz in the industry that about 2000 ICO's have been out, collectively raising roughly $6B USD (+ growing), however, 46% of them have failed by this time. Why is that? Primarily a result of non-compliance with regulatory bodies in the current jurisdiction and beyond. Too many companies are quick to assume the role of a trail blazer and hope that their business will be the unique business that will adjust regulations. However, the secret to sustainable growth and long term success, is to comply and work with regulatory bodies to help them understand your business, the nuances, and how certain regulations can be used to apply / comply with your business in a manner that will be successful for all stakeholders involved.
Gensler stated that to govern this space, the SEC typically assesses the following when concerning ICOs to understand whether the coin/token in question is a security. The four-pronged approach (Howey Test) is as follows:
- Is there an investment of money?
- Is the investment of money in a common enterprise?
- Is there an expectation of profit from the investment?
- Is the profit going to be derived significantly from the efforts of others?
Pertaining to investment contracts or securities offerings, Gensler referred to the December 2017 Munchee order in which the SEC issued a Cease and-Decist order.
Munchee Inc. is a California-based company developing an a restaurant application. Munchee wanted to raise $15M USD to develop their application by selling MUN tokens to investors who could purchase with Bitcoin or Ether. Munchee published a white-paper prior to ICO to help investors understand how the MUN tokens would be issued and how they would be used to develop Munchee's application. Munchee marketed their MUN tokens as functional utility tokens with the intention that once Munchee's stakeholder ecosystem would be developed, MUN tokenholders could earn tokens by writing restaurant reviews etc. At this point, it's imperative to note that Munchee's marketing was in line with the SAFT framework.
However, the SEC conducted a review and ordered a Cease and Decist to Munchee to prevent their token sale. Using the Howey test mentioned earlier, the SEC found 3 key elements in their analysis:
- The SEC was not able to assure that the utility token (as advertised by Munchee) would actually be a utility
- In the white-paper, Munchee ascertained that the MUN tokens could rise in value and be traded on a secondary profit - alluding to the idea that investors could expect profits.
- The SEC found that Munchee's ecosystem focus alluded to the idea that investors would be dependent on the investment of Munchees founding team and staff for tokens purchased to increase overall value of the MUN tokens.
Lesson learned. So what is the SEC also looking at? Gensler addressed the following questions that anyone considering an ICO should consider, as the SEC will be using them as well as the Howey test to understand whether or not the token will be classified as a security.
- Are the tokens immediately usable?
- Are buyers expectations that the tokens will rise in value?
- If so, will an expected rise in value be derived from the efforts of others?
- Will there be a secondary market for the tokens?
- How is the ICO being advertised?
- How are the proceeds of the ICO to be used?
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