On Monday, December 11, 2017, SEC Chairman Jay Clayton waded into the ongoing debate surrounding cryptocurrencies, initial coin offerings, and the regulation of both. In a statement urging potential investors to exercise caution and market professionals to focus on their responsibility to help protect investors, the Chairman warned of the susceptibility of the burgeoning crypto markets to manipulation and fraud.
Capital has poured into cryptocurrencies and related enterprises at an astonishing rate in 2017, both in secondary markets where cryptocurrencies and cryptographic tokens are traded and in ICOs or tokens sales in which participants receive tokens in exchange for funds, often contributed in cryptocurrencies like bitcoin or ether. ICOs alone have raised more than $4 billion this year, and the price of bitcoin has risen more than 15 fold.
The flow of money has caught the attention of the SEC. Throughout the year the Commission has made a number of statements concerning cryptocurrencies and token sales, issued an investigation report concluding that certain tokens may be subject to the securities laws, and taken enforcement action against several allegedly fraudulent ICOs. While the Chairman made clear that Monday’s statement reflects his views and not necessarily those of the SEC, by and large the statement matched the tone and content of this year’s SEC pronouncements in the area.
Clayton addressed his statement to two groups: Main Street investors and market professionals. With respect to Main Street investors, he advised caution. At this time, he noted, the cryptocurrency and token sale markets lack the investor protections in place in the traditional securities markets. Clayton urged investors to inform themselves of the risks associated with these nascent markets, and to do their due diligence before investing. To that end, the Chairman appended a list of sample questions to pose before contributing to a token sale or purchasing a cryptocurrency.
To market professionals, Clayton’s statement was clear: where securities are offered “longstanding securities laws principles” apply, regardless of the form the offering takes. In other words, consistent with prior SEC cryptocurrency-related pronouncements, substance takes precedence over form, and creating a token that represents equity rights or labeling a traditional security instrument a cryptocurrency will not exempt it from the purview of the securities laws. The Chairman emphasized the responsibility of market professionals, including lawyers, accountants, and consultants, to further the goal underlying the security laws—protecting investors, especially the Main Street investors addressed earlier in his statement.
In the statement’s latter half, Clayton turned to a brief analysis of cryptocurrencies and ICOs. The Chairman rejected broad arguments that cryptocurrencies are not securities and are thus beyond the SEC’s jurisdiction, repeating that the fact-driven analysis to determine whether a given transaction is a security will vary from currency to currency. He also noted the SEC’s regulatory power is not strictly limited to securities themselves, offering as an example the Commission’s “sharp focus” on the effect foreign exchange markets have on securities markets.
Concerning ICOs, Clayton took the view that many—if not the majority—of the coins or tokens offered exhibit the “key hallmarks of a security,” including promotional suggestions of returns flowing from secondary market trading or the managerial efforts others will put into the realization of a future product or company. These views may be his own, but they undoubtedly carry weight, not the least because the Chairman, as indicated in his statement, has asked the SEC to continue to aggressively police token sales and take action against violators of the securities laws.
While cautionary, the statement’s characterization of the crypto markets was by no means completely negative. Clayton reiterated the SEC’s commitment to capital formation and its openness to new technologies, and left open the possibility that the tokens offered in some ICOs might not be securities. For ICOs that do offer securities, he suggested the traditional securities law framework should suffice, and in general encouraged market participants to engage with the SEC for help in the analysis of their various enterprises. Overall, the Chairman focused on compliance with existing securities laws and investor protection, potentially a way of legitimizing the market in cryptocurrencies rather than marginalizing it.
Market participants should heed the Chairman’s warnings and proceed with caution when investing, offering or selling coins or tokens, or operating secondary market platforms. If nothing else the statement is yet another clear indication that the SEC will not sit on the sidelines as the ICO and cryptocurrency markets continue to multiply and draw more and more Main Street investors.