ICOs: A Changing Regulatory Environment

And how to choose your advisory team to address this

Regulators are continuing to focus on ICOs and the cryptocurrency market, and many are taking an increasingly forceful approach to exercising their regulatory powers. The commercial importance of this ever-increasing regulatory scrutiny is clear in how the markets have reacted over the past few weeks.

Whilst Chinese and South Korean restrictions on cryptocurrency have had a major impact, the US SEC has been amongst the most public in its regular and detailed criticism and expressions of concern about the industry/market.

The SEC has been increasingly active of late, issuing cease and desist and other orders to prospective ICOs. The latest target of public guidance focuses on ICO advisory teams, as we describe here.

Key Messages from the SEC & other Regulators

Currently, the financial, corporations and securities law implications of ICOs are a particular focus of regulators. In our view, the key messages behind recent guidance from the SEC and other major regulators around the world include:

• Where ICOs run their project on the basis that their tokens are not securities, this does not mean that they are not securities. Merely calling a project an ICO doesn’t change that fact that, from a legal perspective, it could be just an Initial Public Offering run on the blockchain.
• The definition of security is very broad, and could capture a wide range of tokenisation models and arrangements, particularly in some jurisdictions.
• Where ICOs have only ‘high level’, inconclusive, or poorly considered legal advice on whether the tokens are securities, this may be an inadequate or inappropriate way of managing regulatory risk.
• Where ICOs engage lawyers to design ‘security law-beating’ tokens, which are nevertheless presented to the market as securities, this can be a high risk strategy (and may not be effective).
• Generally, ICO legal advisors should be cautious of taking a financial stake in a project where this could compromise the objectivity of their advice — they are there to be independent and provide a view as to the law.
• It may be appropriate for lawyers to have limited involvement in developing the tokenisation model —this should be done separately, and later reviewed by lawyers.
• Even if your token isn’t a security (or a particular country doesn’t have a similar securities law regime to the US), there could be many more corporations/financial regulations to consider.

The Message In Short

A key message of some recent guidance from regulators seems to be: ‘this is a complicated area — be wary of legal/accounting advisors issuing limited advice merely to help get the ‘outcome you want’ (eg that your ICO is issuing ‘utility tokens’) without genuinely considering or applying the law. Even with such ‘advice’, regulators may still pursue your project’ (read: regulations might still be aggressively enforced).

How are regulators approaching ICOs now?

The latest announcements are part of a much broader trend towards global regulators “cracking down” on ICOs (and cryptocurrency more broadly).

Regulators began by issuing cautionary messages, but still taking a largely commercially-minded approach. For instance, the SEC did not aggressive pursue the instigators of the DAO, but used the widely-publicised fact that the project may infringed relevant laws as a cautionary exemplar for future projects.

The market has continued to grow (and some regulators may see it as ‘out of control’), and nefarious ICOs have continued to pop up. Regulators may think that they have to act more forcefully to curtail this trend.

What does it mean for my project?

In our view, there are a few takeaway messages from recent regulatory announcements.

1. Securities law (especially in the US) continues to be a fundamental consideration for projects.

2. If you’re not a US lawyer, but think your project is not a security based on reading online explanations, you may be wrong — securities/financial regulation is a very complicated, and designing IPO-type tokens that aren’t securities can be very difficult.

3. In light of global regulators’ current approach to ICOs, running a project without appropriate advice is commercially very risky.

4. Assistance in designing a tokenisation model that manages various competing regulatory, commercial and economic objectives is increasingly a project imperative.

5. Designing a tokenisation model should be done by a consulting team, not your legal advisors. Legal advisors and project consultants should be separate —consultants can assist with the tokenisation model, but not legal advice. Lawyers should advise on the legal status of the token model, but have limited involvement in designing it, and should also avoid taking a pecuniary interest in the project success.

Lupercal Capital and its team of cryptocurrency experts has provided strategic consulting on ICOs and blockchain to existing businesses and start-ups to help them unlock the potential of crypto-technology.

If you’re thinking of an ICO or blockchain adoption, we’d love to hear from you — go to lupercalcapital.com, or email us at [email protected].

If you’re interested in regulatory developments in cryptocurrency, check out CryptoRDB, the most comprehensive database on cryptocurrency regulation.

Note: Securities, financial, corporations and other law is complicated and varies between jurisdictions. The above is not legal advice, and it may be appropriate to engage a suitably qualified lawyer to advise on the implications of your project.