Kik Answer Claims SEC’s Accusations Are “Factually Misleading”

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A few weeks ago, I responded to a fellow lawyer’s call for Kik to stand down in its fight against the SEC. 

After the SEC’s Complaint, he didn’t think that Kik stood a chance. Though I understood his concern, I knew that we needed to wait to see how Kik would respond.

Now, we have Kik’s Answer, and I’ve just finished going through all 131-pages of it — and man, was it worth it. 

It’s good. Very good. 

It’s well-written, aggressive and it makes the SEC look really bad. 

Read on in today’s article as I give you the latest update in my blow-by-blow account of the SEC vs. Kik face off. I’ll also cover what this could mean for Kik and the fate of all crypto projects. 

Legal Background: What is Kik’s “Answer”?

Before we get started, let me put this latest legal development into context for you. If you’re already familiar with the standard timeline of legal proceedings, feel free to skip to the next section. If not, hopefully, this will help give you a deeper understanding of the case.

First, when a lawsuit is filed, the Plaintiff (the person initiating the legal action) starts things off by filing a “Complaint”. In this case, the SEC’s Complaint alleges certain facts that, if true, indicate that Kik violated securities laws.

Keep in mind that since the Plaintiff is trying to justify the need for a case, it will try to include every possible grievance imaginable. These accusations are not always substantiated by evidence, and as you can imagine lawyers don’t mind exaggerating to make their case. 

Then, the Defendant has a chance to respond to the accusations with an “Answer”. In this case, in Kik’s Answer, the project has a chance to deny (or admit) each of the SEC’s factual assertions. 

Following the Complaint and Answer, the next stage in the lawsuit is a factual discovery process. This is when the fight is taken to court to determine what the actual facts are. 

This process will include written discovery, as well as depositions, where each side brings in witnesses and presents evidence to officially determine the facts.  

Those are the basics of what’s happening. But now, let me add some color to the case.

Kik Strikes Back

To start, let me point out that normally, a Complaint is a rather dry statement with a long list of factual assertions that make the Plaintiff look good and the Defendant look bad.

But for anyone who has read the SEC’s initial Complaint against Kik, you’ll know that the document was far from “dry”. The Complaint went way beyond the norm to make some very colorful and direct attacks against Kik and its CEO. 

Even if you’re not a lawyer, you’d probably be surprised at some of the SEC’s statements.

Yes, this is personal.

The SEC is treating the legal proceedings as an all-out PR campaign against Kik. 

But, Kik is fighting back.

Kik responded with a very well written Answer that not only denies wrongdoing but also aggressively calls the SEC out for its deceptively misleading factual assertions. 

It’s unusual for a defendant to poke the SEC and make this a personal affair, but the SEC fired the first shot and Kik is responding in kind.

And that’s what we love about Kik. Unlike all the other projects the SEC has targeted, Kik isn’t intimidated by this big government agency.

By now, it’s clear. The SEC and Kik are committed to an all-out war. All cordiality is gone. 

In this war, one side will win and one side will lose. 

Of course, attitude alone will not enable Kik to win this case. To win, Kik needs solid legal arguments too.

Kik Claims the SEC is Stretching the Truth

Overall, Kik’s Answer does what it was supposed to do. It does a great job of putting into doubt all of the SEC’s material factual assertions that Kik knowingly participated in an unlawful securities offering. 

This is why I asked Josh Lawler to wait for Kik’s Answer before making calls for Kik to surrender. Because you always have to hear both sides of the story first. 

As I previously stated, Kik’s answer makes the SEC look bad. Really bad. 

According to Kik, the SEC has taken quotes out of context, distorted or ignored relevant facts and even misstated the law. 

If Kik is correct, the SEC may have been intentionally deceptive in its claims.

But that’s not all. In its Answer, Kik takes shots at the SEC all over the place. A few of my favorite quotes include:

“And while it is difficult to explain the Commission’s apparent contempt for the idea that a company would sell a product to generate revenue…” 

You can feel the rebellion, can’t you? Though in order for this stance to have an effect, the judge would have to be generally pro-business. This next quote, however, no judge can ignore:

“Not only is it improper to impute the Commission’s generalized, selective, and unsubstantiated conclusions about token sales to Kik’s sales of Kin, but it is also factually misleading because…” 

As you can see, Kik is aggressively hacking away at the SEC’s assertions. And if what they say is true, Kik could have a very good case. 

This sets the stage for the kind of face-off that we’re going to see in the upcoming depositions. 

The best line, however, was this:

“The Commission’s claims rely on a fundamentally flawed factual and legal premise. As Kik will show, the Commission has selectively edited the facts to carve out a story that it believes satisfies the relevant law.” 

This definitely does not make the SEC look good, and casts a shadow of doubt across the SEC’s entire Complaint. 

Of course, that’s the purpose of the Answer, but usually, a Defendant is only able to refute certain claims, not the overall motivations of the Plaintiff.

We have yet to see how all of this holds up in court. But nonetheless, the proceedings will be juicy.

Challenging the Howey Test

The SEC’s motivations aside, the biggest issue being debated here is the framework for assessing whether or not a token offering is a security offering.

In its Answer, Kik did not only respond to the attacks made against it personally, but it also challenged how the Howey Test should be applied to crypto. 

Over the last year, the SEC has gone back and forth many times on how it determines what is or isn’t a security. 

Last October, I presumed that the regulators would apply standard practice to crypto and published an article on How to Know if Your Token is a Security

But then, just a few months later, the SEC took the stance that all initial coin offerings should be considered security token offerings

That lasted a few months until they turned around again and gave a major exception for ETH based on “decentralization”, which left everyone confused. 

Finally, before the SEC vs. Kik case began, the SEC made one more attempt at clarifying things by publishing its official framework on assessing digital assets. This brought us back to what I said from the start — that the SEC would base its assessment on the Howey Test. 

Now, in its response, Kik is challenging how the Howey Test is applied to ICOs. In particular, the SEC’s Complaint creates a new interpretation of what “decentralization” means not only with respect to a token’s governance, but now apparently with respect to the economy using it.

In Kik’s words:

Howey does not require that a decentralized economy be achieved. The Commission has made up this requirement out of whole cloth… the definition of “investment contract” (as urged by the Commission) is hopelessly vague, and leaves the Commission free to engage in arbitrary and discriminatory enforcement in this space.” 

People on our side of the fence will agree with the last part of the quote. The securities laws are extremely vague.

But the fact is, the SEC likes it that way. The broader the law is, the more discretion the SEC has to pursue who it wants to pursue. 

Even if we assume that the SEC is acting in the best interests of the people, which we do, it still has a major incentive to try to accumulate and hold on to as much power as it possibly can. 

Meanwhile, through this case, Kik is arguing for a more narrow interpretation of the Howey Test. One that would give crypto projects significantly more clarity in how to proceed with token offerings.  

Clearly, the outcome of this lawsuit will impact far more than just Kik alone. It will set the stage for all crypto projects to follow and also which other projects the SEC will pursue.

The SEC’s Words Are Coming Back to Bite Them

Overall, the SEC’s constantly evolving stance created a very uncertain environment for crypto projects. 

But the worst part is that when the SEC established new guidance on its regulations, it could retroactively target the companies whose token offerings had been in violation of its new rules. Even if those regulations weren’t established at the time of their token offering. 

That might not seem fair, but most projects didn’t have the resources to fight back… until Kik. 

Today, as this case goes to court, the SEC is finding that its own words are coming back to bite it. Because now, Kik is able to make the case that Kik did not necessarily hold a security offering according to the SEC’s own criteria:

“In fact, Ethereum – which the Commission has indicated is not a security – operates based on a very similar model.”

At the core of this confusion was SEC Chairman Jay Clayton. Kik’s Answer gives a nice summary of the events as they unfolded:

“For example, Chairman Clayton has made numerous statements directly contradicting each other: in December 2017, he stated: “there are cryptocurrencies that do not appear to be securities…

On April 5, 2018, Chairman Clayton suggested that the application of the federal securities laws to a given cryptocurrency could vary over time, noting that, “[j]ust because it’s a security today doesn’t mean it’ll be a security tomorrow, and vice-versa.”…

Just two months later, when asked to confirm this position, he appeared to back off, saying: “that is a question that is out there, and we’ll be answering the specific facts and circumstances, but we’ve been doing this a long time and there’s no need to change our fundamental approach.”

This shows just how unclear the SEC’s official stance was on the matter of whether or not all token offerings should be considered securities offerings. And how it changed from one month to the next.

But Clayton was not the only one to confuse things…

“Other senior SEC officials have further complicated this picture. For example, in June 2018, Commission Director of Corporation Finance, William Hinman, echoed Chairman Clayton’s earlier suggestion that token transactions can evolve from being a security to a non- security, using Bitcoin and Ether as examples.”

In fact, the SEC’s un-unified stance was so obvious that SEC Commissioner, Hester Pierce even joked about how misguided her colleagues were on the whole situation. Which Kik, of course, highlighted in its Answer:

“Notably, recognizing the confusion of her own colleagues’ positions, Commissioner Hester Peirce has recently stated that, “[i]f you apply the reasoning that some of my colleagues at the SEC have used, there are lots of things that would [qualify as] securities,” using Starbucks gift cards and Chuck E. Cheese tokens as examples.”

The lack of cohesion within the SEC during the past years definitely makes the agency’s job more difficult today. 

Because, even if the SEC can argue that it is clear now what makes a security token offering, it was not clear at the time. And thus, it’s harder to make the case that Kik knowingly violated securities laws. 

What does this mean for Crypto Law Insiders?

For Insiders, this case isn’t just about determining what is or isn’t a security token offering (though that will likely be a subsequent result of the case). 

This case is about reigning in the SEC’s ability to arbitrarily make rules and then retroactively enforce them. And it will shape how the SEC approaches projects in the crypto space overall and who they pursue.

Depending on whether the case becomes political or not, this might even prompt legislators to jump into the fray. Already some US politicians are suggesting that legislation over ICOs is needed to clarify the SEC’s authority over the industry. 

Ultimately, the winner of this lawsuit will greatly change the world of crypto for the foreseeable decade, which is why we are still on the edge of our seats to see how this case will play out in court. 

Dean Steinbeck

Dean Steinbeck

Dean Steinbeck, Managing Director of Crypto Law Insider, is the leading authority on legal issues related to cryptocurrency and blockchain technologies.