The SEC chief has a new warning for ICO investors: Buyer beware

Think twice.
Think twice.
Image: Reuters/Brendan McDermid
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In a statement peppered with boldface warnings, the Securities and Exchange Commission is urging people eyeing crypto-asset investments to exercise “extreme caution.”

“There are tales of fortunes made and dreamed to be made,” said Jay Clayton, chairman of the US regulatory agency, in remarks directed to both “Main Street” investors and market professionals. “We are hearing the familiar refrain, ‘this time is different.'”

Clayton’s statement comes after a frantic start to December for bitcoin, which is based on the same encrypted blockchain technology that underlies other “crypto” assets. Last week saw bitcoin break through new $1,000 milestones every few hours (it’s now at around $17,000). On Sunday, the Chicago Board Options Exchange launched futures trading for bitcoin, seen by some investors as its debut into the mainstream of investing.

Clayton’s statement was also issued the same day the SEC took regulatory action to halt an initial coin offering (ICO).

“Recognize that these markets span national borders and that significant trading may occur on systems and platforms outside the United States. Your invested funds may quickly travel overseas without your knowledge,” he wrote, in a sentence that was in bold.

Clayton’s statement referenced some of the crucial debates that have swirled around the rise and regulation of crypto-assets like bitcoins. Are these currencies? Commodities? Or securities? The statement notes in a footnote that bitcoin in the US has been designated a commodity. But the broader answer seems to be that while it depends from case to case, initial coin offerings, at least, are more likely to be scrutinized and held to the same bar as securities offerings.

While ICOs “can be effective ways for entrepreneurs and others to raise funding… a change in the structure of a securities offering does not change the fundamental point that when a security is being offered, our securities laws must be followed,” said Clayton. “Said another way, replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.”

In other words—if it looks and smells like a security, it’s probably a security, and should be subject the same regulations as ordinary securities. That would require companies staging ICOs to issue standardized disclosures stating the risks involved with investing, or else demonstrate to the SEC’s satisfaction why the product being offered doesn’t qualify as a security.

Between January and October of this year, companies staged over 200 IPOs and raised over $3 billion in funding, with more than half that sum coming after early August. In July, the SEC issued a similar statement urging caution toward participants in ICOs and noted that tokens that had been offered by The DAO, an organization that raised $150 million in an ICO, were securities, though it did not pursue any charges or make findings of violations.

On the same day as the Clayton statement, the SEC halted a $15 million IPO from restaurant review site Munchee by issuing a cease and desist (.pdf). The regulator argued that the company’s MUN tokens were a form of securities that it was selling “without having a registration statement filed or in effect with the Commission or qualifying for exemption from registration with the Commission.” Munchee has refunded its investors, according to the SEC.

The SEC chair goes on to warn of the dangers involved for individual investors. “To date no initial coin offerings have been registered with the SEC.  The SEC also has not to date approved for listing and trading any exchange-traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies,” he said. “If any person today tells you otherwise, be especially wary.”  (Emphasis in the original statement.)

“As with any other type of potential investment, if a promoter guarantees returns, if an opportunity sounds too good to be true, or if you are pressured to act quickly, please exercise extreme caution and be aware of the risk that your investment may be lost,” he wrote, before closing with a list of questions that investors should ask themselves before putting money into an ICO.

For example, an investor should inquire exactly who is the party that is offering the contract, and what the money is going to be used for—will funds raised be used to “cash out” other investors, for example? The full list is worth a read, and might just come in handy for journalists covering the sector too.