One of the big questions surrounding ICOs is whether the “coin” (or token) offered in the ICO is considered a security and, therefore, subject to securities laws, including registration.  One of the U.S. SEC’s first official statements on the matter, issued in response to the DAO debacle, was probably most famous for its lack of definitive statements.  It said that:

[F]ederal securities law may apply to various activities, including distributed ledger technology, depending on the particular facts and circumstances, without regard to the form of the organization or technology used to effectuate a particular offer or sale

Of course, the test to be applied to determine whether somethings is a “security” is the well-known Howey test:

A contract constitutes an investment contract that meets the definition of security if there is (i) an investment of money; (ii) in a common enterprise; (iii) with an expectation of profits; (iv) solely from the efforts of others (e.g., a promoter or third party), “regardless of whether the shares in the enterprise are evidenced by formal certificates or by nominal interest in the physical assets used by the enterprise.”  SEC v. Howey, 328 U.S. 293, 298 (1946).

The Supreme Court has reaffirmed the Howey analysis as recently as 2004 in SEC v. Edwards, 540 U.S. 398 (2004). On its face, it would seem like most ICOs would qualify as a security under the Howey test.

This conclusion was supported by SEC Chairman Jay Clayton’s Public Statement on December 11, 2017, in which, in response to efforts by some lawyers to call ICO tokens “utility” tokens and thereby bring them outside the securities law regulations, he said:

Merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.  Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law. . . .

Prospective purchasers are being sold on the potential for tokens to increase in value – with the ability to lock in those increases by reselling the tokens on a secondary market – or to otherwise profit from the tokens based on the efforts of others.  These are key hallmarks of a security and a securities offering.

One of the first enforcement actions by the SEC with respect to ICOs concerned Munchee, Inc. Munchee was seeking $15 million 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 digital tokens.  The company communicated through its website, a white paper, and other means that it would use the proceeds to create the ecosystem, including eventually paying users in tokens for writing food reviews and selling both advertising to restaurants and “in-app” purchases to app users in exchange for tokens.   In December 2017, after being contacted by the SEC, Muchee agreed to an order in which the Commission found that its conduct constituted unregistered securities offers and sales.  Munchee agree to halt its ICO and refunded the $60,000 it had taken in in the first two days of the ICO.

There have also been private lawsuits.  A few days ago, a class action lawsuit was brought against Bitocin mining company Giga Watt.  Significantly, among other relief sought is rescission — a return of the invested funds.   Section 12(a)(1) of the Securities Act in the United States gives investors the right to recover the consideration they paid, with interest, from any person who “offers or sells a security in violation of [the registration requirements of] section 5,” without the need to show fraud and irrespective of the good intentions or other mental state of the issuer.  Plaintiff’s release accompanying the lawsuit stated:

It is important for investors in companies that raise funds utilizing an Initial Coin Offering to know that all pre-functional token sales fit the U.S. laws’ definition of the sale of a security, which means the seller either has to comply with U.S. securities laws by registering the product or obtain a government-granted exemption from those laws before conducting the sale.  In this case, the defendant — whether intentionally or not — did neither and is therefore strictly liable for offering and selling unregistered securities.

This follows on the heels of four class actions lawsuits brought against Tezos, which raised $232 million worth of cryptocurrency during its two week ICO in July 2017.  In the first of these cases, the federal district court in California denied a temporary restraining order that sought to enjoin the defendants from selling, transferring, converting, or otherwise disposing of any assets collected or derived from the ICO, holding that plaintiff had failed to show that he is likely to suffer irreparable harm in the absence of injunctive relief.


David Zaslowsky has a degree in computer science and, before going to Yale Law School, was a computer programmer. He is currently the Chairman of the Litigation Department of the firm’s New York office. His practice focuses on international litigation and arbitration. He has been involved in cases in trial and appellate courts across the United States and before arbitral institutions around the world. Many of David’s cases, including some patent cases, have related to technology. Since 2008, David has been included in Chambers for his expertise in international arbitration.