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From Bitcoin to Ethereum, The Rise of Initial Coin Offerings Draws Regulatory Scrutiny

By Jake Zindulka of Shustak Reynolds & Partners, P.C. posted on Monday, November 27, 2017.

Jake Zindulka
619.696.9500 ext. 114
[email protected]

The amount of capital raised through initial coin offerings (ICOs) has increased exponentially in just the last year. So far, in 2017, companies have raised over $3 billion compared to approximately $300 million raised between 2014 and 2016. 

ICOs are similar to initial public offerings, though ICO investors typically do not receive an ownership interest in the offering company.  Instead, through an ICO, a company raises funds by offering digital coins or tokens to investors. The coins or tokens are then used to purchase products or services on the company’s platform. Investors may also trade the digital coins on various online exchanges.  

Of course, not all ICOs are successful. Recently, one company, Bancor, raised over $150 million in an ICO. Since the offering, however, the value of the company’s digital coin plummeted 50%. Meanwhile, another company, Confido, raised almost $400,000, only to completely vanish after the ICO.   

The fast increase in ICOs has brought increased regulatory scrutiny. The SEC noted in a recent investor bulletin that digital coins may be considered securities, and therefore subject to federal securities laws. Meanwhile, the Wall Street Journal recently reported that SEC Chairman Jay Clayton said he has “yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security.” Not all digital coins will automatically be deemed securities:  The SEC will analyze whether a coin is a security on a case-by-case basis. In July, the SEC issued a Report of Investigation that analyzed whether a specific digital token used by a company to raise capital was a security under federal law. The SEC applied the test that the Supreme Court established in SEC v. W.J. Howey Co., 328 US 293 (1946) and ultimately concluded that the digital tokens were securities.

In September 2017, moreover, the SEC brought charges against two companies and their founders for fraudulently selling digital tokens to investors. In the complaint, the SEC alleged violations of registration and antifraud provisions of federal securities laws. The SEC also issued a warning that celebrity promotions or endorsements of ICOs might be unlawful after several celebrities promoted ICOs through social media. Other countries have also begun to scrutinize ICOs; earlier this year, both China and South Korea banned ICOs.  In addition to recent regulatory actions, private lawsuits involving ICOs have been on the rise. Recently, two class-actions were filed against Tezos, a company that raised over $200 million in an ICO, for alleged violations of state and federal securities laws. The increasing use of ICOs will continue to attract regulatory scrutiny and private civil lawsuits.

Jake Zindulka is one of our Law Clerks at Shustak Reynolds & Partners, P.C.

Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. For more information, or if you or your company require counsel in these areas, contact us today for a confidential, complimentary consultation.

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