Crypto currencies continue to be a key focus for the Commission. Using the analysis in the DAO Section 21(a) report which builds on the Howey investment contact test, the agency continues to bring actions alleging that crypto offerings are unregistered securities. The analysis is typically built on the notion that investors pool their money with the hope of profits from the efforts of others.
A central question in the Howey analysis, however, may be what constitutes the efforts of others. This might mean, for example, pooling the investor cash into a firm where the efforts of others involve a manufacturing process that creates the prevernal widget which is later sold. If, however, the investors purchase coins known to be in limited supply which are then promoted using their capital by one who has an interest in seeing the price go up, is that “Howey efforts of others?” Stated differently, if the “ecosystem” around the coins causes their value to increase does that transform it into a security?
Consider the Commission’s latest crypto case, SEC v. Kik Interactive, Inc., Civil Action No. 19-cv-5244 (S.D.N.Y. Filed June 4, 2019). Kik is a privately-held Canadian corporation based in Waterloo, Ontario. Founded in 2009 the firm’s only line of business was the Kik Messenger, a mobile software application that permitted users to communicate with each other on mobile devices.
By 2016 the popularity of the Kik Messenger app waned. Revenue was minimal at about $2.2 million from mid- 2015 through mid 2016 while expenses were approximately $32.2 million. It was time for a pivot to a new model. Kik found it in the idea of an ICO involving crypto currency. The Canadian based firm decided to create a crypto story as a new way to raise capital – and survive. The Kik CEO summarized the strategy this way: The firm would “’sell some [tokens] to crypto investors to raise money,’ and that ‘[m]ore demand’ for the token would mean ‘[v]alue goes up’ and, therefore: ‘Buy today, sell tomorrow, profit.’”
By May 2017 Kik’s CEO told the board that he expected to announce a token – named a Kin – offering that month. The proceeds from the offering would be used to build the “’Kin Ecosystem’ and fund company operations.” Three million tokens would be offered in multiple tranches. The funds would be committed in advance of each offering in exchange for discounts.
Key to the offering was the sales pitch – it posited the opportunity for profits. The sales pitch focused on “Kik’s vision that it would profits alongside other Kin investors, because the value of Kin held by both Kik and outside investors would increase as Kik helped increase demand for Kin.”
The value of other digital assets was increasing during the Kin promotions. That fact was used to promote the Kin. The company also assured investors that the Kin would have tradability.
From the beginning of the public announces regarding the Kin, the company emphasized its “central role” in promoting the coins was well as its obvious interest in the overall success of the program in view of its Kin holdings. The company also emphasized its expertise and ability in promoting the coins.
Investors were repeatedly told by Kik that their investment capital would be used to promote the “Kin Ecosystem” in which Kin could be used to buy goods and services. Kirk also claimed that the Messenger app would be modified, and other promotions would be funded through investor capital created to promote the Kin.
Overall about 10,000 investors paid approximately $100 million for the digital assets. The offering was never registered with the Commission. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). The complaint is pending.
FCPA Institute: On June 21 and 22, 2019, Professor Mike Koehler will conduct the FCPA Institute at the Offices of Dorsey & Whitney LLP in Minneapolis, Minnesota. The Institute provides a unique learning experience for those seeking to elevate their knowledge of the Foreign Corrupt Practices Act. Professor Koehler is one of the foremost scholars on the FCPA and conducts an interesting and most informative program. The program is live in Minneapolis and also webcast. You can obtain more information about the program and register here.