Munchee Inc. ("Munchee"), a California-based restaurant review company, shut down its initial coin offering ("ICO") and issued refunds to investors after the SEC issued a cease-and-desist order for failing to register the tokens as a security.

Munchee allegedly created and planned to sell 500 digital tokens ("MUN" or "MUN tokens") with the goal of raising $15 million in capital to advance business development efforts. Munchee represented that the MUN tokens would be used as payment for authoring food reviews and to purchase food at participating restaurants. Munchee also represented that the value of the tokens would increase as a result of the company's efforts to develop the MUN "ecosystem," and emphasized that MUN would be tradeable on secondary markets.

The SEC determined that the Munchee ICO was an "investment contract" and, therefore, a security under the "Howey Test" (SEC v. W.J. Howey Co.). Under the Howey 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 entrepreneurial or managerial efforts of others. The SEC found that MUN tokens were securities because purchasers had a reasonable expectation of profits from Munchee's creation and development of an "ecosystem" where an expanding group of restaurants, reviewers and restaurant-goers would want to acquire the finite number of MUN tokens.

After the SEC contacted Munchee regarding the ICO, Munchee stopped selling MUN tokens and returned the proceeds to investors. The SEC ordered Munchee to cease and desist from further Section 5 violations.

Commentary / Jeff Robins

The significance of yesterday's action far outsizes the Munchee ICO or the penalty imposed. Unlike previous SEC actions around ICOs, there were no allegations of fraud and Munchee does not appear to have made any claims that holders of tokens would participate directly in profits of the company. Further, the MUN tokens were clearly intended to be "utility tokens" that could be used to purchase goods and services in the Munchee ecosystem once it was built. This is, thus, the first ICO in which the SEC found the Howey Test satisfied based solely on the expectation that token values would rise because of scarcity created through efforts of the issuer.

Munchee may have been particularly explicit about running its business in ways that would cause MUN tokens to become scarce and rise in value in order to appeal to speculators. For instance, the company detailed plans to take MUN out of circulation when restaurants paid advertising fees, and to "tier" the amount it would pay for restaurant reviews based on the MUN already held by the reviewer. But the basic dynamic of scarce tokens and expanding ecosystems is what fuels speculation in many (if not most) ICOs and cryptocurrencies.

The Munchee action, therefore, signals a broader crackdown on unregistered ICOs that are marketed to speculators. Indeed, the SEC seems to have opened the door to an even wider application of Howey, noting that the test requires an assessment of "the economic realities underlying a transaction" and that MUN would likely have been securities even if the tokens had a practical use at the time of the ICO.

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.