If you’ve been following the evolution of cryptocurrency and digital assets, then you understand (or can at least appreciate) the mass confusion that “half-in/half-out” government regulations have created. No greater is this confusion and grey area than in relation to ICOs.

An ICO [Initial Coin Offering] is a capital-raising tool similar to an IPO [Initial Public Offering] except that investors purchase virtual currency tokens instead of equity shares of the offering company. ICOs, though largely unregulated to date, have become increasingly scrutinized by regulatory agencies, namely the SEC [Securities & Exchange Commission] and the CFTC [Commodity Futures Trading Commission], that deem certain characteristics of the transaction to fall within its purview of “stuff” to be regulated.

Kik, the Canada-based company known for its messaging app, is currently stage-front in one battle that should help clear up some of the ambiguities surrounding ICOs. On Tuesday, June 4, 2019, the SEC filed a lawsuit against Kik, charging the company with failing to register its $100 Million ICO. The 49-page complaint filed in the Southern District of New York alleges that Kik carried out its ICO in a manner that made the offering an investment contract, which is a security subject to SEC regulation that required Kik to register its offering. The complaint further alleges that Kik was running out of money (which it failed to disclose to investors) and used the ICO as a “last ditch effort” to preserve its existence.

As articulated in its published April 2019 Framework, the SEC will be arguing that analyzing whether the offer/sale of a digital asset is an investment contract must be done by applying the Howey test. Under this test, an investment contract exists when there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.

The April 2019 Framework provides detailed commentary for assessing each of the elements of the Howey test:

·      Investment of money – Is the digital asset acquired in exchange for value?

·      Common enterprise – Are the fortunes of the digital asset purchasers linked to each other or to the success of the promoter’s efforts?

·      Reliance on the efforts of others – Is the promoter, sponsor, or other third party providing essential managerial efforts that affect the success of the enterprise.

·      Reasonable expectation of profits – Do the investors reasonably expect to derive profit from the efforts identified in the previous element?

Although the outcome of the SEC’s filing is far from clear, industry practitioners and participants are hopeful that it will provide at least some clarity and guidance that can be used in structuring future ICOs.