The SEC Office of Investor Education and Advocacy ("OIEA") cautioned investors about risks associated with investing in the microcap stock of companies "claiming to be related to, or asserting they are engaging in," Initial Coin Offerings (or "ICOs"). Although companies employ ICOs for legitimate purposes, the OIEA warned, fraudsters often use hot and poorly understood emerging technologies like ICOs as lures for fraud.

In a recent Investor Alert, the OIEA noted that increasing media attention to ICOs may create situations in which companies announce ICOs in order to affect the price of their common stock. The OIEA said that it recently issued several trading suspensions for the stock of microcap companies touting ICOs. The OIEA explained that a trading suspension could result from (i) insufficient available information about a company, (ii) questions concerning the accuracy of available information about a company, and (iii) questions about stock trading, including insider trading, market manipulation, and the ability to clear and settle trades. As such, the OIEA asserted, investors should consider past trading suspensions as warning signs of possible microcap fraud when evaluating whether or not to invest in a company's stock. The OIEA also warned investors about market manipulation strategies, including "pump-and-dump" schemes, in which companies make misleading representations in order to manipulate the price of stocks and then unload shares of those stocks at artificially inflated prices.

The SEC urged investors to better equip themselves to spot potential fraud, particularly with regard to ICOs, by (i) considering publicly available information, including financial disclosures, as well as information on companies' websites and from other internet sources, (ii) proceeding with caution when evaluating whether or not to make investments with "non-reporting" companies, and (iii) being skeptical of stock promotions, particularly from companies that do not offer detailed compliance information, or that offer vague/misleading information related to an ICO. The OIEA also offered a number of tips for identifying signs of ICO-related fraud. These signs can include unsubstantiated claims that an ICO is "SEC compliant," and the use of vague or undefined technical jargon.

Commentary / Jeffrey Robins

The latest in a series of warnings about ICOs, this investor alert is another signal that the SEC is increasingly concerned about fraud in this space. In an initial coin offering, transferable electronic tokens recorded in distributed ledgers using blockchain technology are created and distributed, often in exchange for cash or virtual currency. Depending on the rights these tokens convey in their associated blockchain platform and how they derive value, they may be securities under the Supreme Court's Howey test. Many ICO distributers are clearly aware of the Howey test and work to limit initial distributions to offshore investors and/or structure their offerings in ways they believe will avoid securities characterization. While this particular investor alert deals with microcap frauds that are clearly within the SEC's jurisdiction, the real question for the industry is whether the securities laws are, or should be applicable to the ICOs themselves.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.