“It will only be a matter of time before the regulators get involved and instigate appropriate measures to ensure the man or woman in the street does not get compromised.” - Tim Lea, author of the book Down The Rabbit Hole: Discover The Power of the Blockchain.
In a July 25 press release that sent shockwaves through the blockchain community, the U.S. Securities and Exchange Commission (SEC) announced that DAO Tokens, a Digital Asset, are considered securities for regulatory purposes, cautioning that US Securities law "may" apply to offers, sales, and trading of interests in virtual organization, targeting the increasingly popular Initial Coin Offerings.
The regulatory body released a comprehensive report into the failed DAO project, as well as a declaration that ICOs may fall under US securities laws. The report stems from an inquiry by the agency’s Enforcement Division into whether The DAO and related entities and individuals violated federal securities laws with unregistered offers and DAO Token sales in exchange for the virtual currency ether.
While the DAO has been widely considered in some circles as a "crowdfunding contract" it would not have met the requirements of the Regulation Crowdfunding exemption due to, among other things, that it’s not registered with the SEC and Financial Industry Regulatory Authority as a broker-dealer or a funding portal. As a result, those who utilize ICOs to sell tokens, an asset class that has now surpassed over $1 billion in net proceeds, will have to register them as securities.
Further, those participating in unregistered offerings may face fines for violations of the securities laws, with the purpose of the registration, "to ensure that investors are sold investments that include all the proper disclosures and are subject to regulatory scrutiny for investors' protection." In addition, securities exchanges that offer trading services in these securities for individuals must register unless they are exempt.
As its first official action of oversight over ICOs, the SEC noted that "whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction."
Said SEC Chairman Jay Clayton in a public statement:
"The SEC is studying the effects of distributed ledger and other innovative technologies and encourages market participants to engage with us. We seek to foster innovative and beneficial ways to raise capital, while ensuring – first and foremost – that investors and our markets are protected."
Perry Woodin, CEO of the Blockchain accounting and governance firm Node40 says that breakthrough advancements in technology often gives way to the rapid acceleration of new business ideas. He noted that the number of businesses supporting blockchain applications has exploded over the past couple of years, and with them, we’ve seen new tools for raising capital.
“The issues that crop up during these cycles of rapid business acceleration often lead to individuals taking a chance with compliance. As we have seen with blockchain, those taking a position that their actions fall into a legal gray area are often shocked to find that compliance is black or white.”
Continued Woodin, “The SEC’s report on ICOs was not a surprise. Many of the ICOs were aiming for that compliance gray area. They wanted their offerings to be considered “crowdfunding" even though they could not meet the requirements of the Regulation Crowdfunding exemption. Now we’ll see what happens as companies attempt to fit within the SEC’s guidelines.”
Steven Nerayoff, a noted venture capitalist, attorney, and early Ethereum advisor added, “The SEC’s decision reinforces what the blockchain industry already knew; federal securities laws apply to all new types of technologies. If anything sold has the characteristics of a security, one must follow U.S. securities laws. This is the case for all technologies. And it should be expected that any organization that fails to comply with the requirements of U.S. securities laws will be held responsible.”
Nerayoff said that the key feature of the DAO Token was indeed an expectation of profit if the investments made by the DAO were successful, and thus the DAO Tokens were expressly sold as an investment. Unlike a token such as ether, he says, the DAO token had no other utility.
Nerayoff reiterated that the SEC’s ruling is not specific to blockchain companies or digital tokens:
“As the SEC developed a more nuanced understanding of this burgeoning industry, it was inevitable that it would begin to develop a body of law and interpretations surrounding it. The blockchain industry as a whole should welcome the SEC’s decision as an important step towards improved regulatory guidance and clarity.”