Recent US guidance on 'initial coin offerings' (ICOs) could help investors misled into supporting unscrupulous fund-raising schemes to recover their money, a commercial litigator has said.
Michael Fenn of Pinsent Masons, the law firm behind Out-Law.com, said: "If investors intend to recover losses suffered as a result of misleading statements made during fund-raising exercises such as ICOs, they may need to consider court proceedings to seek recovery. Under English law, the potential remedies that might be available to investors will depend on a number of factors, including; the circumstances of the investment, any pre-investment representations relied on, promotional material provided and any contractual documentation signed."
Fenn was commenting after the US Securities and Exchange Commission (SEC) secured undertakings from two businesses that had operated ICOs in breach of requirements under US securities laws. The undertakings will see the companies provide "harmed investors" with claim forms to enable those investors to apply to recover the money they paid when investing through the ICOs.
While the SEC's regulatory settlements were with US-based companies, its approach to enforcement could influence regulators elsewhere in the world too, he said.
Offers of securities worldwide are subject to the US securities laws. Offers of securities outside of the US are conducted pursuant to exemptions or safe harbours from the registration requirements under the US securities laws.
According to the SEC, both Airfox and Paragon Coin raised millions of dollars through ICOs for digital projects without registering their ICOs under US securities laws first. Neither company qualified for an exemption from the registration requirements, the US regulator said.
The SEC imposed a $250,000 penalty on both businesses under the terms of regulatory settlements which Airfox and Paragon Coin agreed to without admitting or denying the SEC's findings. The US regulator said it was the first time it had imposed civil penalties on two businesses for the sole reason of failure to register their ICOs.
Both businesses have agreed to register their tokens as securities under the Securities Exchange Act of 1934 and file periodic reports for at least a year to the SEC.
Co-director of the SEC’s enforcement division, Steven Peikin, said the regulatory orders "provide a model for companies that have issued tokens in ICOs and seek to comply with the federal securities laws".
"Despite the fact-specific finding by the SEC, guidance in this area is important to decrease the potential for fraudulent and illegal ICOs globally," Fenn said. "The SEC's decisions may influence the market and be followed by or influence regulators around the world."
Last year, the SEC published a report clarifying that it considers businesses that offer and sell virtual currencies as a means of raising capital to be subject to securities regulation in the US.
In that report, the SEC said: "Whether or not a particular transaction involves the offer and sale of a security – regardless of the terminology used – will depend on the facts and circumstances, including the economic realities of the transaction. Those who offer and sell securities in the United States must comply with the federal securities laws, including the requirement to register with the Commission or to qualify for an exemption from the registration requirements of the federal securities laws."
"The registration requirements are designed to provide investors with procedural protections and material information necessary to make informed investment decisions. These requirements apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralised autonomous organisation, regardless whether those securities are purchased using US dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology," it said.
"In addition, any entity or person engaging in the activities of an exchange, such as bringing together the orders for securities of multiple buyers and sellers using established non-discretionary methods under which such orders interact with each other and buyers and sellers entering such orders agree upon the terms of the trade, must register as a national securities exchange or operate pursuant to an exemption from such registration," the regulator said.
The SEC's 2017 report was prompted by an investigation it carried out into a German business, Slock.it, which had developed digital tokens to sell to investors. According to the report, however, some of Slock.it's assets were stolen by hackers. The theft occurred before the money accumulated from the sale of the digital tokens could be used to fund business projects that were intended to benefit from the investment. Slock.it had pledged to share earnings from those projects with investors in its tokens, the report said. The SEC decided against taking enforcement action in that case.
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