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The Consequences Of SEC Decisions: No More Utility Tokens?
08 January 2019 12:15, UTC
The SEC lawsuits surrounding Airfox (Carrier EQ, Inc) and Paragon Coin Inc showcase that the regulator is intent on pursuing clear cases of unregistered securities regardless of whether or not the project was fraudulent. Under the settlement, each company will refund its investors, pay $250,000 fines, and comply with increased reporting to the SEC.
In the case of EtherDelta, the SEC pursued its founder, Zachary COBURN, and not the project itself, even though he had sold it in 2017.
It looks like that, moving forward, much of the focus could be on exchanges. Even if an ICO project has a utility case that the regulator is willing to accept as a defence that they were not marketing unregulated security, the act of trading the tokens on the secondary market creates an unregistered broker-dealer situation. Projects found to have issued unregistered security may have to refund funds to investors, pay financial penalties, and register as security under Section 12(g) of the Securities Exchange Act of 1934 before continuing to issue an offering.
As with exchanges, we are also seeing the SEC starting to go after those who market ICOs deemed to be fraudulent or manipulative. Floyd MAYWEATHER was recently fined $614,775 because he was paid $100k to celebrity endorse Centra Tech. DJ KHALED was also fined $152,725 for the same project after receiving $50k for his endorsement.
If improper KYC/AML was undertaken for an ICO, those projects are experiencing increased treasury management difficulties as they convert their tokenized capital into fiat to pay expenses. Even if a given token sale was properly organized, they may experience secondary market liquidity issues if most exchanges continue to be unregistered. Given these two issues, projects that are unable to effectively move forward on their stated project goals will face increased litigation from their investors as well as potential regulatory action. These examples make it clear that the SEC considers the vast majority of historical ICOs to be securities, regardless of the utility of their token. In any case, it is understood that moving forward almost every ICO will be viewed as a security and will need to conform to securities regulations or face regulatory action.
At this stage, pure utility ICO fundraising is dead, at least in the case of future utility. It could come back depending on how the markets respond, but it would seem that the investor community has wisened up to the unlikely financial outcomes of these projects. Given the restrictions that securities registration will place on retail investor participation, the size of any successful offerings will be much more restrained.
So what are the options? Well, you could actually try building a real venture the way that it has worked historically for decades by bootstrapping and raising equity capital. If you have a revenue-generating business model, like a SaaS, platform, or mobile app, you might also have an attractive proposition for issuing a revenue sharing security token offering instead.
So for people building companies with realistic, scalable business models, tokenization will continue to offer funding alternatives, but there will be no escaping proper regulation.
Image courtesy of Fine Art America
About the author: Ethan Pierse is the Director of the CryptoAssets Institute, evangelizing the Business of Blockchain and the Tokenized Economy. He is in love with tokenized securities.
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