Last month, the SEC issued guidance regarding securities offerings, investment vehicles, exchanges, and broker-dealer rules and how each applies to the crypto industry.
Although much of the content was unpleasant for crypto-related businesses to digest, the regulatory certainty it provided was needed.
Following the SEC release, I received several inquiries from projects that went ICO in 2017. They all had the same question:
“If I raised money via an unregistered ICO in violation of US securities laws, how do I fix my situation?”
Fortunately, the SEC addressed that point. It used its action against two unregistered ICOs, AirFox and Paragon, as a roadmap for other ICOs to follow as a path to compliance:
“These two matters demonstrate that there is a path to compliance with the federal securities laws going forward, even where issuers have conducted an illegal unregistered offering of digital asset securities.”
So, if you’ve raised money via an unregistered ICO and want to avoid jail, please read on to learn the 4 steps you’ll need to take.
1. Pay a Penalty
Do the crime, pay the fine.
Nothing exemplifies the US justice system like its desire to impose financial penalties on wrongdoers. The SEC is no exception to this rule. If you have completed an unlawful ICO, be prepared to pay the consequences.
In the cases of both AirFox and Paragon, the SEC imposed financial penalties in the amount of $250,000 each. Although the SEC has a lot of discretion in determining the size of a fine, it seems safe to assume that if you voluntarily follow the path set out by the SEC, you will face similar fines.
Given the possible outcomes here, a fine of $250,000 indicates that the SEC wants to signal that there are serious consequences to unlawful behavior, but does not want to make those consequences so severe that nobody will voluntarily agree to pursue them.
2. Register with the SEC
All securities offerings that solicit US investors must either be registered with the SEC or fit within an exemption. Registration statements provide investors with the information they need to understand the securities offered, the issuer’s business and the risks associated with investing.
Accordingly, the SEC required both AirFox and Paragon to retroactively register their security offerings with the SEC. This, unfortunately, is an extremely expensive and burdensome undertaking. Ironically, if you launched an ICO that’s probably the reason you opted to not register with the SEC in the first place.
By requiring AirFox and Paragon to register their securities, the SEC is indicating that the rules of traditional securities offerings apply equally to crypto. As Stephanie Avakian, Co-Director of the SEC’s Enforcement Division explained:
“We have made it clear that companies that issue securities through ICOs are required to comply with existing statutes and rules governing the registration of securities.”
So if you’ve raised money via an unregistered ICO, be prepared to hire pricey US securities lawyers and accountants to help file paperwork with the SEC. Depending on the professional service firms used and the size of the offering, expect to pay anywhere from $500,000 and up for this.
3. File Quarterly and Annual Reports with the SEC
Sadly for companies (but happily for their lawyers and accountants) the SEC reporting burden doesn’t end following the completion of a securities offering.
Instead, even after registering, you will need to submit periodic reports to the SEC that include updated financial statements, business descriptions, and other material information investors need to continue making an “informed investment decision”.
If you want to see what sort of information this entails, just visit the SEC EDGAR database.
AirFox and Paragon are both required to comply with this reporting framework going forward, as will be the case for you, if you want to come into compliance.
Annual compliance with these filings and audits can vary significantly depending on the professional service firms you use. At a big, prestigious law firm like the one I used to work at, you can expect to pay an arm and a leg.
4. Give your Investors Rescission Rights
As I reported from the DCG Summit in Lake Tahoe, the SEC believes that the “right of rescission” is an important remedy to provide investors following security offering violations.
What is rescission exactly?
The right of rescission is a legal remedy that allows investors who participated in unregistered securities offerings to unwind their purchases. Essentially investors can return their tokens and receive their original investment back.
If you’ve raised money via an unregistered ICO, be aware that you will have to offer your investors the right of rescission and be prepared to buy back their tokens at the original offering price.
Unfortunately, you may determine that this is not economically possible, as the majority of the money you raised has already been spent on engineering efforts.
You are not alone in this. This last requirement will be the most difficult for most companies to comply with, by far, and will likely result in a large number of ICO-related bankruptcies.
If the price of your token is significantly lower than its issuance price, and your company doesn’t have the cash to buy back the tokens, I suggest you seek legal counsel ASAP.
What does this mean for Crypto Law Insiders?
The SEC has spoken and it would be wise for us to listen.
If you raised money via an ICO in violation of US securities laws, the SEC has given you a clear path to follow if you want to “fix” your situation.
This path may be painful and unpleasant, but there aren’t many good alternatives. The SEC is not going to stop pursuing companies that raised money via an unregistered ICO.
As SEC Enforcement Division co-director Stephanie Avakian stated:
“These cases tell those who are considering taking similar actions that we continue to be on the lookout for violations of the federal securities laws with respect to digital assets.”
The SEC’s enforcement agents have made it clear that Airfox and Paragon are just the first ICOs to be targeted. If you have completed an unregistered ICO, you could be next. I highly recommend you reach out to legal counsel immediately. It pays to be proactive and take action before you land in the SEC’s crosshairs.
As we’ve seen, though AirFox and Paragon have suffered financially, they are still around and their executives are not in jail.
I’ve said this before but it bears repeating. The long arm of US law enforcement is long. Very long. Living in Zug won’t protect you. Insiders should take action as soon as possible.