The Securities and Exchange Commission (“SEC”), through its new Cyber Unit, recently obtained an emergency asset freeze against Dominic Lacroix, his partner, Sabrina Paradis-Royer, and his company, PlexCorps, for a fraudulent Initial Coin Offering (“ICO”). The SEC’s complaint alleges that they sold securities claiming investments in PlexCoin would bring profits of 1,354% in less than 29 days. Among other things, the complaint said, “Lacroix was a known recidivist securities law violator in Canada; the proceeds from the PlexCoin ICO were not destined for business development but instead were intended to fund Lacroix and Paradis-Royer’s expenses including home décor projects; and there was no reasonable basis to project returns on investment.” Since August, the ICO has raised $15 million from thousands of investors in the U.S. and elsewhere.
This was the first case filed by the Cyber Unit, which was created in September to focus on cyber-related misconduct involving ICOs and distributed ledger technology. As the SEC noted, this was a “full-fledged cyber scam” and “exactly the kind of misconduct the unit will be pursuing.”
On December 11, the SEC’s chairman, Jay Clayton, released an official statement urging caution on cryptocurrencies and ICOs. He reinforced the commission’s premise that whether or not a particular token constitutes a security depends on the facts and circumstances of each case. Specifically, he warned investors and market participants of the risks surrounding “utility” tokens and to be wary of promoters asserting their tokens had utility and therefore were not securities, “Many of these assertions appear to elevate form over substance. Merely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security.” He emphasized that where tokens and offerings include features and marketing efforts that promote the potential for profits based on the entrepreneurial or managerial efforts of others were the “hallmarks of a security.” He also gave a few examples. Where the tokens represented a participation interest in a book-of-the-month club, they were unlikely to constitute securities. However, where the tokens represented interests in a yet-to-be-built publishing house with the authors, books and distribution networks all to come, they were more likely to constitute securities.
Particular red flags Clayton noted were where the offerings emphasize the secondary market trading potential of the tokens, where the tokens being offered were to be used in a platform or for products that had not yet been built and where the offering emphasized form over substance. Recently, a California-based company shut down its ICO after questions from the SEC raised concerns that the offering constituted a sale of unregistered securities. Munchee Inc. was seeking to raise $15 million to create an “ecosystem” focused on restaurant reviews where users were paid in tokens for writing reviews and where advertising to restaurants and “in-app” purchases were made in exchange for tokens. Among other things, the company promoted the idea that efforts by the company and others would lead to an increase in the value of the tokens and that the company would help to create a secondary market for the tokens. The SEC ultimately decided not to impose a penalty on Munchee recognizing that “the company stopped the ICO quickly, immediately returned the proceeds before issuing tokens, and cooperated with the investigation.”
While Clayton noted the SEC is committed to promoting capital formation in transformative and efficiency enhancing ways, he also highlighted the need for investor protection and transparency. The SEC has yet to bring an enforcement action, in an ICO context, in the absence of fraud. It is unclear the extent to which the SEC’s new Cyber Unit will continue to center its attention on obvious cases of fraud such as PlexCorps or whether the SEC will start pursuing “honest” ICOs purely on the basis that they are offerings of unregistered securities.
Our post from last summer discussed an SEC investigative report in which the SEC stated that US securities laws apply to sales of securities in the United States purchased with virtual currencies or distributed with blockchain technology, and an Investor Bulletin cautioning potential investors about ICOs.