Howard Marks


The SEC Exposes the ICO Rabbit Hole

It really does not matter how many times you cry wolf. It is clear almost no one in the ICO marketplace listened to the SEC’s clear and precise admonition. Well, as I predicted, the SEC just issued a comprehensive list of subpoenas to many of the companies and their promoters who raised capital through an ICO.

This story was broken by the Wall Street Journal, and they probably got an insider track at the SEC, although they are not commenting. The article claims ICOs raised $6.5B in 2017 and so far $1.66B this year! If these numbers are anything close to the truth, it is clear the SEC is not going to let anyone get away.

The Hit List

  • CEOs, C-level executives and board members of companies who issued utility tokens without registering with the SEC or using an exemption. This includes an overwhelming number of ICOs.
  • Promoters who helped market the offerings. These include marketing firms who are getting paid in tokens based on an ICO’s success. They cannot receive commissions unless they are a registered member of a broker dealer.
  • Advisors who were listed on ICO websites to help signal their endorsement of the offering and were sometimes paid in percentages of their contribution to the raise. Same as promoters, they cannot receive commissions unless they are a registered member.
  • Platforms who listed the ICOs and were paid in commissions and clearly did not disclose their compensation nor were they registered members.
  • Bounty hunters who marketed the ICO on social media and were solely compensated in utility tokens based on the total amount of investments they were able to capture.
  • Professionals who may have advised their clients on how to best avoid regulation through deep analysis of the utility token although it was clear the ICO was marketed to investors.

So why is this really big news? Clearly no one was interested in what the SEC had to say. After all, according to crypto enthusiasts, the government was going away, and we were going to live in a regulation-free society. It made sense because in a decentralized world, Bitcoin was king.

Enough of the wild fantasies. The SEC was formed in 1934 to help protect investors, and today that is exactly what they are doing. All of the rules which were implemented by the SEC are more than meaningful: they are the law.

The Great Rescission

So what is a company who issued a utility token ICO supposed to do? Well, there is some good news and some bad news. Let’s start with the good news. A company can meet with their attorney and craft a new offering, this time using one of the SEC exemptions, and offer a rescission to all of its investors.

Careful, this requires a very experienced attorney who understands securities laws and is an expert at this type of offering. A company offers a rescission to investors if they discover they did not properly sell securities. Investors who receive a rescission offer have 30 days to either accept it or reject it. Should they accept the offer and reinvest, then they cannot have further claims about the securities violations. In a way, the rescission is a clean-up job. A second chance for the company.

A famous case is Google who in 2004 filed a rescission offer for 23 million shares issued to employees and consultants. Guess what? Everyone agreed to the offer and reinvested. However, they received the offer to receive their money back with interest (which was different for each State)!

It is now clear that 2018 is going to be a year where many companies who raised capital in an ICO using a utility token will spend time with their attorneys formulating rescission offers. This is the good news.

No Good Deed Goes Unpunished

Investors can still sue the company even when they offer a rescission, but in reality if the investors get their money back, how can anyone claim damages? The bad news is this: it is not clear if some of the companies will be able to formulate a rescission because they cannot make an offer to non-accredited investors, who could comprise a large portion of their raise.

Why not? The only way to legally offer the rescission would be to file the rescission under Regulation Crowdfunding or Regulation A+ which allows non accredited investors to invest. It is not clear if the SEC would approve this. Probably worth trying if you ask me.

The consequence for everyone involved in an ICO that did not use an SEC exemption is that the SEC can tie the company up in legal discovery for a long time, including asking the justice department to sue the company, the founders and anyone involved in the promotion. These consequences are no fun because they involve restitution to the investors, stiff penalties and possible jail time. Along with all of this, there could be a 10 year or permanent ban for selling securities for those who violated security laws.

What Is the Cure?

Clearly rescission is the cure every ICO needs. Some platforms are starting to offer it, and attorneys are licking their chops. The ICO marketplace is going to continue to grow, this time in the real world, using the beautiful regulations the SEC has prepared for all of us.

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