With a gob of money being thrown at Initial Coin Offerings (ICOs) of late and breaking records amid the price of Bitcoin hitting new highs, the U.S. Securities & Exchange Commission (SEC) has issued a statement in relation to “celebrities and others” using social media networks to encourage the public to purchase stocks and other investments.
“These endorsem*nts may be unlawful if they do not disclose the nature, source, and amount of any compensation paid, directly or indirectly, by the company in exchange for the endorsem*nt,” a statement from the SEC issued this Wednesday read. And, indeed there is a lot of money sloshing around in the space with ICOs having raised around $2 billion so this year, with a plethora of ventures from across the industry spectrum tapping the market.
The SEC’s Enforcement Division and Office of Compliance Inspections and Examinations is encouraging investors to be “wary of investment opportunities” that sound too good to be true.
“We encourage investors to research potential investments rather than rely on paid endorsem*nts from artists, sports figures, or other icons,” it added. The SEC noted that celebrities and others have recently promoted investments in ICOs.
Citing their Report of Investigation (July 25, 2017)concerning The DAO, a Decentralized Autonomous Organization created by Slock.it and Slock.it’s co-founders, the U.S. financial regulator warned that virtual tokens or coins sold in ICOs may be securities, and those who offer and sell securities in the United States “must comply with the federal securities laws.”
As such the Commission stressed that: “Any celebrity or other individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion.”
Failure to disclose such information constitutes a “violation of the anti-touting provisions of the federal securities laws.”And, it said that people making these endorsem*nts may also be “liable for potential violations of the anti-fraud provisions” of the federal securities laws, for participating in an unregistered offer and sale of securities, and for acting as unregistered brokers.
Golden Bitcoin money on computer concept. (Image: Shutterstock).
As Charles Hoskinson, formerly an Ethereum co-founder who in 2015 foundedIOHK, a leading blockchain R&D company, said to me in relation to ICO’s recently: “Once people realize they can make money through this mechanism [ICOs] many people are going to try. It’s a value transfer mechanism.”
The American from Boulder, Colorado, whose IOHK team over the past two years designed Cardano, an “industrial-strength” blockchain, added: “It does not, however, replace basic business principles such as due diligence, use of funds, who comprises the management, what is the business plan and how the entity in question is going to execute on its plan.”
He added: “An ICO - a token - has to have a right to exist, it has to perform something and have some form of a utility. It cannot be used to capitalize an endeavour.” But people often forget about such things. One could even talk about the merits of Sci-fi ICOs and real ICOsas well as the question as to how of these ICOs will succeed at the end of the day.
In respect of the SEC’s 18-page statement on DAO from July, Hoskinson noted: “The SEC was very careful in their reading [of the landscape] and every word it used was carefully chosen. What they said in relation to the DAO, if it was a ‘normal’ vehicle like a venture capital fund or an equity offering, all the facts and circ*mstances would say you would have absolutely register with the SEC.”
But ICO entities or offerings effectively saying that because they are decentralized and they are somehow immune from regulation won’t wash. The SEC’s opinion was that such an approach cannot be taken. As Hoskinson pointed out using an analogy: “If you call a duck a rooster, it doesn’t change the fact that it’s a duck.”
However, at the time of the SEC’s statement they did not take a position “on the meat” of what is going on in the cryptocurrency space according to Hoskinson. For example, they did not comment on utility tokens. So it leaves the door open to more positions and statements coming in due course.
Investor Protection
The SEC said it will continue to focus on these types of promotions in order to protect investors and to ensure compliance with the securities laws. Its mission is after all to maintain fair, orderly and efficient markets as well as facilitate capital formation and promote a market environment worthy of the public's trust.
It minded investors to note that “celebrity endorsem*nts may appear unbiased, but instead may be part of a paid promotion.”Therefore, investment decisions should not be based solely on an endorsem*nt by a promoter or other individual.
“Celebrities who endorse an investment often do not have sufficient expertise to ensure that the investment is appropriate and in compliance with federal securities laws,” the latest statement added. The need for research to be conducted before making investments, including in ICOs, was underlined by the Commission.
“If you are relying on a particular endorsem*nt or recommendation, learn more regarding the relationship between the promoter and the company and consider whether the recommendation is truly independent or a paid promotion,” it said.
Why the U.S. regulator has waited until now to issue a statement on this issue given the bubble developing in terms of the number of ICOs, token sales and crowdfunds makes one wonder. At least they are upping the ante.
And, who knows if this will be the precursor to fines, litigation against market participants in the crypto space and prison sentences down the line for those who transgress. This is against a backdrop of the number of ICOs showing no sign of slowing down in what might be described as a feeding frenzy.
It all rather reminds me of a quote by Dr John Bates, a fintech and Big Data pioneer and CEO of Testplant, who referred to “regulators chasing Ferrari’s on bicycles.” He wasn’t at the time referring to ICOs, but rather high frequency trading (HFT) and algorithmic traders in that space.
For more information, anInvestor Alertfrom the SEC’s Office of Investor Education and Advocacy has been issued regarding celebrity endorsem*nts.
The SEC has also provided additional resources including an Investor Bulletin: Initial Coin Offerings, an Investor Alert: Public Companies Making ICO-Related Claims, and an Investor Alert: Social Media and Investing - Avoiding Fraud.
