Here we go again. Companies issuing tokens are trying any way they can to circumvent securities laws. The new and fashionable way to run an ICO is to sell the tokens to a small group of whales ($1M or more in crypto assets) in a private sale without any disclosures to the public and then airdrop a boat load of tokens later to anyone who signs up to a Telegram group.
The real goal of the airdrop is to create a large group of token holders to better facilitate listing on exchanges and create more liquidity. Exchanges love that and are more likely to list a token held by 10,000 people than by 100 investors.
There is even a new website to aggregate all of the airdrops. The party is just getting started. Millions of crypto investors are going to get millions of free tokens just for signing up to a website and becoming a proud member of a new group they actually do not necessarily care about.
Searching with the #airdrop hashtag reveals thousands of free offers for investors.
So why would that be a securities transaction with non-accredited investors? After all, the company is giving away the utility tokens for FREE. However, it turns out that there is no such thing as a free security or “Free Stock,” according to the SEC.
The SEC is constantly alerting the marketplace saying that most utility tokens are securities, and their method of sale proves it. A small private sale under Regulation D to accredited investors is permitted. The company can just privately disclose what it wants to the investors. After this private sale is completed, the tokens are not magically transformed into utility tokens: they remain securities.
Free is a very catchy concept. However, asking a user or investor to join a Telegram chat group instantly makes the word FREE false because the user has offered something of value (albeit not cash) to the company. The value they provided is that they joined a group and can now be contacted.
Some companies pay up to $1 to get a Telegram user in their group. After all, a large Telegram group is a clear signal of a popular ICO. Thus telling investors to come and join and get free security tokens is a sale of securities to non-accredited investors, whether or not they confirmed their ID against OFAC following the Bank Secrecy and USA Patriot Act.
In such cases, the company has not relied on an exemption from Securities Act registration when making the airdrop for “free.” Those who are well advised could use the Regulation Crowdfunding or Regulation A+ exemptions to make an airdrop, and this would be legal. However, how would they value those free security tokens?
It seems that the company can demonstrate a reasonable basis for a security token based on previous sales and restrictions. For example, if the pre-sale sold the security token for $1 with a one year trading restriction under Regulation D, then the free token under Reg A+ could be valued at $2 because it has no trading restrictions. Ah ha! This is great because with Regulation A+, up to $50M of security tokens could be given away for “FREE” to any U.S. based consumer.
It is clear the SEC is going to review all of these airdrops carefully and may well issue a bulletin alerting the marketplace about this practice. This could be the next shoe to drop.
This article is co-written by Howard Marks and Sara Hanks. Sara Hanks, co-founder and CEO of CrowdCheck, is an attorney with over 30 years of experience in the corporate and securities field. CrowdCheck provides due diligence, disclosure and compliance services for online capital formation. Its services help entrepreneurs and project sponsors through the disclosure and due diligence process, give investors the information they need to make an informed investment decision and avoid fraud and help intermediaries avoid liability.
Sara’s prior position was General Counsel of the bipartisan Congressional Oversight Panel, the overseer of the Troubled Asset Relief Program (TARP). Prior to that, Sara spent many years as a partner of Clifford Chance, one of the world’s largest law firms. While at Clifford Chance, she advised on capital markets transactions and corporate matters for companies throughout the world. Sara began her career with the London law firm Norton Rose. She later joined the Securities and Exchange Commission and as Chief of the Office of International Corporate Finance led the team drafting regulations that put into place a new generation of rules governing the capital-raising process.
Sara received her law degree from Oxford University and is a member of the New York and DC bars and a Solicitor of the Supreme Court of England and Wales. She served as Co-Chair of the SEC’s Advisory Council on Small and Emerging Companies which recently ended its term. She holds a Series 65 securities license as a registered investment advisor. Sara is an aunt, Army wife, skier, cyclist, gardener and animal lover.