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Resolving an ICO-Security Offering – The Terms Have Changed

The Commission has frequently reiterated its view that initial coin offerings or ICOs may involve the sale of securities in the form of an investment contract based on the traditional Howey analysis. Early cases such as Munchee, settled in December 2017, focused on what the agency called the “ecosystem” that would bring profits to investors from the efforts of others if they purchased interests in an ICO. That case resolved with a consent to the entry of a cease and desist order based on Securities Act section 5. The firm halted the offering when contacted by the staff and promptly return all the investor funds. The DAO section 21(a) report reiterated the view ultimately articulated in Munchee.

Nevertheless, ICO’s which involved securities continue without registering the offerings or finding an exemption. While Munchee may have been the model for resolving early cases where the parties wanted to comply with the federal securities laws, the terms have changed. Now, those conducting such offerings may have to consent to a cease and desist order and return the investor funds and also pay a penalty to settle with the Commission. The point is illustrated by In the Matter of Carriereq, Inc., D/B/A Airfox, Adm. Proc. File No. 3-18898(Nov. 16, 2018).

Airfox initially sold technology to mobile telecommunication firms in the U.S. That technology permitted customers to earn free or discounted airtime or data by viewing advertisements. It was called AirFox Wireless.

The company decided to launch a new, consumer-facing business line in mid-2017 with the AirFox App, a beta version of its branded internet browser application. Android smartphones users would be able to earn an AirToken by viewing advertisements on the AirFox App. The tokens could be exchanged for free airtime or data from multiple prepaid mobile telecommunications providers. To facilitate this model AirFox planned to purchase mobile data time in bulk from prepaid mobile carriers.

The company developed a plan to raise capital through the sale of AirTokens by August 2017. The plan called for AirFox to introduce a mobile application that would permit users to earn AirTokens and exchange them for free or discounted mobile data and other goods and services. The tokens would be issued on the Ethereum blockchain.

A white paper was posted on the firm’s website. Investors were told that their funds would be used for future development of the AirFox App and the AirToken ecosystem to expand the services to international markets, add a microloan component for AirToken holders and broaden the use of AirTokens outside of the firm’s applications. The white paper described the ecosystem as being created by AirFox with the tokens serving as a medium of exchange. The company also told investors that it was planning to enter into agreements with token exchanges to ensure there would be trading in the secondary market. AirFox detailed the prospects for development of the ecosystem on blogs, social media, online videos and online forums.

Under the terms of the offering investors agreed that they were acquiring AirTokens for their utility as a medium of exchange, not as an investment or security. Investors did, however, expect the value of the tokens to increase through the firm’s managerial and entrepreneurial efforts. Indeed, AirFox did not market the ICO to anticipated users of the AirFox tokens – individuals with prepaid phones in developing countries. Rather, the firm focused on investors who reasonably viewed the tokens as a speculative, tradeable investment vehicle that might appreciate based on the efforts of AirFox.

The ICO was completed on October 5, 2017. About $15 million was raised. 1.06 billion AirTokens were sold to over 2,500 investors. The tokens were available in the U.S. and other countries through a series of controlled websites.

Under the circumstances here the interests offered in the ICO were in fact investment contracts under within the meaning of the DAO report and Howey. Investors looked to the development of the ecosystem through the efforts of the firm for profits. The Order alleges violations of Securities Act sections 5(a) and (c).

To resolve the proceedings, Respondent agreed to implement a series of undertakings which require that all investor funds be repaid. The firm also consented to the entry of a cease and desist order and agreed to pay a penalty of $250,000. See also In the Matter of Paragon Coin, Inc., Adm. Proc. File No. 3-18897 (Nov. 16, 2018)(similar ICO offering also found to be the illegal sale of securities; settled on similar terms).

Program: The Fifth Annual Dorsey Federal Enforcement Forum will be held on December 5, 2018. The program, centered on a tech theme and SEC enforcement, includes a keynote address on artificial intelligence and its impact on the legal profession, panels analyzing critical issues facing SEC enforcement, the question of broker protocols, trends in investment adviser inspections, how to conduct an ICO and concludes with an address on cyber-security and internal controls. A holiday gathering follows. The program and registration for it and the party are here or separate registration for the holiday party only here.

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