By Stephen M. Quinlivan
The SEC issued an investigative report cautioning market participants that offers and sales of digital assets by “virtual” organizations are subject to the requirements of the federal securities laws. Such offers and sales, conducted by organizations using distributed ledger or blockchain technology, have been referred to, among other things, as “Initial Coin Offerings” or “Token Sales.” Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.
The SEC’s Report of Investigation found that tokens offered and sold by a “virtual” organization known as “The DAO” were securities. The DAO sold tokens representing interests in its enterprise to investors in exchange for payment with virtual currency. Investors could hold these tokens as an investment with certain voting and ownership rights or could sell them on web-based secondary market platforms. Based on the facts and circumstances of this offering, the Commission, as explained in the report, determined that the DAO tokens are securities.
The DAO’s intended purpose was to “To blaze a new path in business for the betterment of its members, existing simultaneously nowhere and everywhere and operating solely with the steadfast iron will of unstoppable code.”
Because the tokens were found to be securities, offers and sales of the tokens were therefore subject to the federal securities laws. The report confirms that:
- Issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies.
- Those participating in unregistered offerings also may be liable for violations of the securities laws.
- Securities exchanges providing for trading in these securities must register unless they are exempt.
The SEC’s report stemmed from an inquiry that the agency’s Enforcement Division launched into whether The DAO and associated entities and individuals violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for “Ether,” a virtual currency. The DAO has been described as a “crowdfunding contract” but it would not have met the requirements of the Regulation Crowdfunding exemption because, among other things, it was not a broker-dealer or a funding portal registered with the SEC and the Financial Industry Regulatory Authority.
In light of the facts and circumstances, the SEC decided not to bring charges in this instance, or make findings of violations in the report, but rather to caution the industry and market participants: the federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology.