No, Not All ICOs Are Securities

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Paul Paray is an attorney in Allendale, New Jersey, focused on privacy and technology matters.

In his Feb. 8 opinion piece for CoinDesk, Santander's Julio Faura suggests that "utility tokens are a bad idea" because it would be a "lie to ourselves" to suggest initial coin offerings (ICOs) were not actually selling securities.

Rather, in Faura's opinion "we should collectively work on a framework to build a clearly defined scheme for ICOs, recognizing from the very beginning that they are securities." And, this "ICO process should be designed in collaboration with regulators to comply with securities law."

Faura's opinion piece does not exist in a vacuum. In a report dated Feb. 5, Goldman Sachs' global head of investment research suggests that investors in ICOs could possibly lose their entire investments - which ties to Faura's underlying premise that ICOs should be regulated "to protect investors."

It is not clear how his proposed hybrid solution would ever get implemented, given it requires complete buy-in from capital markets and regulators, so it would be a non-starter from day one.

Why would existing financial institutions and regulators scuttle existing methods of raising capital or attempt to squeeze ICOs under traditional securities law, even if considered a sale of securities?

Answer: They would not. Ripple - a company partially funded by Santander InnoVentures - offers a glimpse of how traditional banks and financial markets will compete using blockchain technology and "coins."

Faura's opinion piece paints all ICOs with the same brush by claiming each one of them actually offers securities subject to U.S. Securities and Exchange Commission (SEC) scrutiny. That is simply not the case.

Indeed, does Faura wonder why the SEC has not knocked on Ripple's XRP "digital asset" door? Even though there was no formal ICO to launch that arguably centralized token, it now trades on 18 exchanges where individuals can buy the XRP coin. Indeed, after raising nearly $94 million of venture capital, Ripple probably does not need an ICO.

One ICO left untouched by the SEC was "gate-keeped" by the law firm of Perkins Coie and involved the sale of a utility token that raised $35 million in under a minute's time. Brave's token creates a digital advertising ecosystem tied to consumer attention - which is why it is dubbed the Basic Attention Token. Such an ecosystem would certainly be an upgrade from the current digital advertising scheme wedded to the web ecosystem of 1995.

Reasonable regulation
All told, it seems that the SEC and other regulatory bodies have actually taken a very measured approach in this area - aggressively focusing on obvious fraudsters first in order to deter subsequent fraudsters, while letting the technology play out a bit in the wild.

Not surprisingly, the plaintiff's bar has been doing a good job picking up the slack in those instances when the SEC has not yet moved. See Davy v. Paragon Coin, Inc., et al., Case No. 18-cv-00671 (N.D. Cal. January 30, 2018) and Paige v. Bitconnect Intern. PLC, et al., Case No. 3:18-CV-58-JHM (W.D. Ky. January 29, 2018).

Recent indicators seem to back this interpretation of the SEC's ICO position.

On February 6, SEC chairman Jay Clayton acknowledged before the Senate Banking Committee that the potential derived from blockchain was "very significant." His co-witness, Commodity Futures Trading Commission chairman Christopher Giancarlo, went so far as to say there was "enormous potential" that "seems extraordinary" for blockchain-based businesses.

Yet, during his testimony, Chairman Clayton said the SEC would continue to "crack down hard" on fraud and manipulation involving ICOs offering an unregistered security. This is consistent with prior messaging given that Chairman Clayton requested on December 11 that the SEC's Enforcement Division "vigorously" enforce and recommend action against ICOs that may be in violation of the federal securities laws.

Chairman Clayton said the SEC was "working the beat hard" to crack down on ICOs, but chose not to answer a question posed of him by Senator Mark Warner of Virginia, namely whether the SEC will "go back" and scrutinize earlier ICOs.

In other words, there may be some ICOs, like the one for BAT, that the SEC will not attack, notwithstanding Clayton's comment in the hearing that "every ICO I've seen is a security."

The prospect that some 2017 ICOs raising hundreds of millions of dollars will not be addressed by the SEC provides a clear "nudge wink" that not all ICOs come under SEC regulatory control.

As with XRP and BAT, in the future, there will likely be many more tokens built on disruptive blockchain initiatives that escape SEC scrutiny given they are not perceived as securities.

The fact that the SEC has not yet moved on them - despite moving against Munchee, Inc. weeks after the Munchee MUN offering - signals the SEC will temper its enforcement activities when faced with a disruptive blockchain initiative that begets true intrinsic value.

In other words, utility tokens may be a good idea after all.