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Morrison Cohen’s Jason Gottlieb
Discusses STO Regulations and SEC Enforcement



Jason Gottlieb:

The SEC and the CFTC have effectively been going after three different kinds of violators. The first kind are the really terrible ones. The flat-out frauds where they say, “Hey, I’m going to sell you some Jason coin if you give me a dollar.” They take the dollar and then they say, “See you suckers.” Those folks are getting in a lot of trouble, not just with the civil authorities like the SEC or the CFTC, but the Department of Justice is coming into criminally prosecuted.

The second level of activity that the SEC and CFTC are going after are projects that are legitimate projects. There really is a Jason coin. There really is a project behind it, but it’s being sold with fraud. “I’m telling you, if you buy into this project, you’re going to make 1000% in a week.” That sort of thing is looked down upon by the civil authorities. You can’t make those kinds of promises. They violate the securities laws. And the SEC has been going after those kinds of promises for fraud very harshly.

But now we’re seeing the third level, which is a legitimate project that’s not allegedly being sold with any fraud, but it is a coin that is really a security but was sold in an unregistered securities offering. And we’ve seen that lately in two big ones. First is the SEC’s action against Kik for violating the registered security provision section five of the 1933 act for offering a coin that was unregistered. When they say it’s a security, Kik’s defense is this really wasn’t a security. This is a token that has functionality in our system and shouldn’t be a security. And Kik has recently bet the entire future of their company on that question.

The second recent SEC action is against a company called ICO Box, or I-C-O Box, and its principal and Nikolay Evdokimov. What Evdokimov was telling people was he’s got an ICO for you in a box. He’ll do it all for you. And the SEC recently sued him in the central district of California saying, “Not only were you offering your own coin to do this, which was a security, but you are also acting as an unregistered broker dealer.” So again, not fraud, but foot-faults, registration violations, those sorts of things. I expect we’re going to see a lot more of that kind of lawsuit over the course of the rest of 2019 and 2020.

The SEC released guidance on what is or isn’t a security token versus a utility token. The guidance was somewhat helpful in that the SEC laid out a lot of factors for lawyers and principles to consider. Unfortunately, it didn’t give a lot of guidance. It said, “Here are 30 factors, and if some of them are one way or the other, then maybe it’s a security and maybe it’s not.” Generally, lawyers are being much more cautious after the big bubbles in 2017 that resulted in all of these enforcement actions. Around the time that the SEC released this guidance, they also released a no action letter for a company that was offering a token that was essentially prepaid use of a corporate jet. And the SEC said, “This truly is not a security, this is really a token.” But everyone in the community looked at it and said, “Yeah, of course. No one would ever think that that’s a security.”

And in fact everyone’s favorite SEC commissioner, Hester Peirce, came out and said that this was affirmatively unhelpful for the SEC to have issued because it doesn’t tell practitioners anything that they didn’t already know. It wasn’t some practical guidance. We saw one more no action letter for the company Pocketful of Quarters that was very much the same way. Nobody really thought that this token for use in virtual gaming was going to be a security. In fact, the New York Virtual Currency Law, which everyone dreads for being so draconian and so restrictive, literally has an exception carved into it for video game tokens that are used in game. So nobody would’ve thought that that was a security. So unfortunately, we don’t have a lot more guidance from the SEC on this utility token versus security than we did six months ago or a year ago or two years ago. All we have is the SEC speaking through enforcement actions and their enforcement actions say it’s all a security.

That’s a great question because I’ve seen two different paths emerging. One path is engage early, engage often. The SEC has set up its FinHub where it makes officers of the staff available to ask questions, to go over projects and to try to seek some guidance. And I have had some conversations with them. I’ve had mixed results. Honestly, a lot of their questions we’ll ask and if they don’t have a good answer for it, they say, “Well, we don’t know. Just follow the securities laws,” which frankly is not particularly helpful. Another strand of thought says, “You know something? We know what the rules are. We’re just going to play very conservatively on clearly this side of the line and we’re not going to engage the SEC. We’ll go our own way. Maybe they won’t notice us. If they do notice us, they’ll think we are trying really hard to stay on the good side of the line. And in that way we’ll be able to launch our business without getting in trouble with the SEC.”