For the second time in less than a month (click here for a prior enforcement action), the SEC’s newly created Cyber Unit has shut down an initial coin offering (ICO). This time the ICO was for Munchee, Inc., a California-based developer of an iPhone application for people to review restaurant meals. The recent enforcement activity follows several policy statements and warnings regarding ICOs. The Munchee order was also issued the same day that SEC Chairman Jay Clayton issued renewed warnings to both main street investors and market professionals regarding ICOs and cryptocurrencies.
The Munchee ICO involved the sale of digital tokens to be issued on a blockchain, or a distributed ledger. Munchee hoped to raise $15 million through this sale. The SEC caught wind of the ICO and halted it after approximately 40 sales because it determined that the ICO constituted the unlawful sale of unregistered securities.
The SEC has emphasized that the test for determining whether a coin or token is a security for federal securities registration purposes is no different than the test applicable to other potential securities. The key question is whether the investor had a reasonable expectation of deriving profits from the entrepreneurial or managerial efforts of others. In determining that Munchee’s coins constituted securities, the SEC cited efforts by Munchee to increase the value of the tokens and make them available for sale on secondary markets. Munchee also made statements on social media and on podcasts suggesting that the tokens would increase in value. Importantly, the SEC emphasized that even if tokens had a practical use at the time of the offering, it would not preclude them from being a security.
Munchee started selling tokens on October 31, and by November 1 the SEC had contacted Munchee, leading to the end of the ICO. Munchee also agreed to return all proceeds it had received to token purchasers. In exchange for Munchee’s cooperation, the SEC did not take further punitive action.
The enforcement action is yet another reminder that the SEC will continue to be extremely active in all areas of cyber regulation. It is also an important reminder that “securities” come in all different forms and that even newer, more modern iterations of securities must be registered with the SEC. In Chairman Clayton’s ICO policy statement, he noted that while not all ICOs implicate securities registration requirements, a large majority of them involve the sale of securities and require registration. Chairman Clayton concluded the policy statement by noting that he has asked the SEC Division of Enforcement to “police this area vigorously,” and take appropriate enforcement action, strongly suggesting that there is more enforcement activity in the future.