By C. Todd Gibson and Evan Glover
On July 25th the United States Securities and Exchange Commission (“SEC”) released a report to put the market on notice that offers and sales of digital assets are subject to the requirements of the federal securities laws.
The report is a result of an investigation of a German created entity called The DAO (Decentralized Automated Organization), which is a virtual organization that exists within computer code and is executed on a blockchain or decentralized ledger. The DAO sold DAO Tokens, which had characteristics similar to stock (e.g. certain ownership and voting rights), with the intent to raise funds to finance various projects. The DAO Tokens were purchased using a digital currency and could be monetized by re-selling the token on a web-based platform that supported a secondary market. The DAO engaged in these offers and sales in the U.S. despite not registering with the SEC.
The SEC decided to issue a report to warn the industry and the market instead of recommending enforcement or making a finding of a violation of the federal securities laws against The DAO. The SEC made the following findings:
- the description of The DAO as a “crowdfunding contract” does not satisfy the requirements of Regulation Crowdfunding because, among other reasons, it was not a registered broker-dealer or funding portal (as that term is defined in Regulation Crowdfunding);
- regardless of whether the issuing entity is a traditional company or a decentralized autonomous organization, the federal securities laws apply to those who offer and sell securities in the United States;
- the investment of money in an investment contract does not need to be cash, the rules apply regardless whether those securities are purchased using U.S. dollars or virtual currencies;
- the federal securities laws apply to virtual organizations or other capital raising entities that use distributed ledger technologies; and
- any web-based platform must register as a National Securities Exchange or operate under an exemption from registration if the organization or association brings together orders of multiple buyers and sellers of securities and uses established, non-discretionary methods under which buyers and sellers interact with each other.
In short, the report voices the SEC’s position that “the automation of certain functions… does not remove conduct from the purview of the U.S. federal securities laws.”
The full SEC report can be found here.