The SEC charged a Canadian issuer with the offer and sale of an unregistered initial coin offering ("ICO") to U.S. investors.
According to the Complaint, the issuer – Kik Interactive Inc. – did not register its digital token "Kin" with the SEC, nor did it provide the appropriate disclosures to investors, as required by federal securities laws. Between May and September 2017, Kik offered and sold one trillion Kin for approximately $100 million.
The SEC seeks to permanently restrain and enjoin Kik, whose digital token is currently being traded on unregulated trading platforms at approximately half of its initial value.
Commentary / Steven Lofchie
The SEC case against Kik is an important one in that it is likely to help define the parameters of the jurisdiction of the SEC over cryptocurrencies as "securities." The question is whether an ICO is a security as measured by the so-called "Howey Test." Under the Howey Test, two of the key measures are:
First, (i) is the purchaser of a digital token acquiring the token to use it as a medium of exchange (in which case it should not be a "security") or (ii) is the purchaser acquiring the token on the expectation (or at least hope) that it will rise in value (in which case, it is being purchased as an investment asset, and so is more likely to be a "security"); and
Second, (i) if the purchasers are acquiring the asset for investment, are they dependent on the efforts of others, who are essentially in a management role to make a profit (which would make the investment more like a "security") or (ii) is the possibility of a profit independent of any efforts by a management or insider group (in which case the token would less likely be a security)?
Essentially, Kik's argument is that its token is being acquired for its use value as a medium of exchange, and not for investment purposes; and that Kik token purchasers were not dependent on the value of Kik management. Kik's position paper may undermine its argument. As to the dependence on Kik management, the position paper says, "simply creating a digital currency is not enough. For a cryptocurrency to be viable, it must also be useful and valuable. To establish an economy around the new currency, Kik must help to establish [the] fundamental value." As to the reasons for purchasing the Kik token, the position paper says: "[the token] will sit at the center of a new digital economy . . . , driving demand and fundamental value for the cryptocurrency." This is at least suggests that buyers of the Kik token may profit from a rise in its "fundamental value."
Developers of cryptocurrencies, who wish to stay outside of the securities laws, need to consider how their product descriptions align with the requirements of the Howey Test. At a minimum, Kik's paper raises serious questions in that regard: it effectively concedes that success of the product is dependent on the management of others. So the question then turns to the motivation of token buyers: are they buying for use or for the hope of a rise in value?
Ultimately, the product developers who have the strongest arguments of being outside the securities laws are the "stablecoin" developers, as that product is marketed as being linked to the value of a particular currency, so that there is no possibility that the asset's value will increase beyond the value of the currency to which it is pegged. See Subject to Strict Conditions, SEC Agrees that "Tokens" to Pay for Services Are Not "Securities. "
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