In the financial regulator’s strongest statement yet, SEC chair Jay Clayton said: “If a promoter guarantees returns, if an opportunity sounds too good to be true, or if you are pressured to act quickly, please exercise extreme caution and be aware of the risk that your investment may be lost.”
Clayton warned investors to ask several questions before investing in cryptocurrencies or “initial coin offerings” (ICOs), including “are there substantial risks of theft or loss, including from hacking?” and “is the offering legal?”
“A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation,” Clayton added.
His statements were not entirely negative. “I believe that initial coin offerings – whether they represent offerings of securities or not – can be effective ways for entrepreneurs and others to raise funding, including for innovative projects,” Clayton said. “However, any such activity that involves an offering of securities must be accompanied by the important disclosures, processes and other investor protections that our securities laws require.”
The focus of Clayton’s concern is that cryptocurrencies change the manner of financial trading, but not the legal basis for regulation. “Said another way, replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.”
While the statement makes clear that the SEC views the cryptocurrency market as falling under its purview, it remains much more laissez-faire about enforcement than other regulators have been. South Korea has simply banned ICOs, noting in September that “stern penalties” would be levied on anyone issuing one.
Under Clayton, who joined the SEC in January following a nomination from President Trump, the Commission has been cautiously expanding its enforcement of cryptocurrency regulation. On the same day as his statement, the organisation announced that it had successfully dissuaded a company from launching an ICO to raise funds for its “blockchain-based food review service”.
“Munchee was seeking $15m in capital to improve an existing iPhone app centered on restaurant meal reviews and create an ‘ecosystem’ in which Munchee and others would buy and sell goods and services using the tokens,” the SEC said. “In the course of the offering, the company and other promoters emphasised that investors could expect that efforts by the company and others would lead to an increase in value of the tokens. The company also emphasised it would take steps to create and support a secondary market for the tokens.”
Those actions, the SEC said, meant it was fair to conclude that Munchee was offering a security that fell under the regulator’s purview. “A token can be a security based on the long-standing facts and circumstances test that includes assessing whether investors’ profits are to be derived from the managerial and entrepreneurial efforts of others,” it said. Munchee agreed to withdraw the offering, avoiding a penalty from the Commission.
Stephanie Avakian, co-director of the SEC’s enforcement division, said: “We will continue to scrutinise the market vigilantly for improper offerings that seek to sell securities to the general public without the required registration or exemption. In deciding not to impose a penalty, the Commission recognised that the company stopped the ICO quickly, immediately returned the proceeds before issuing tokens, and cooperated with the investigation.”
