October 29, 2020
Update: After nearly two years of battling with the SEC, Kik was finally defeated. Luckily, it’s not all bad news. The SEC offered Kik a settlement of just $5 million. This is an exceptionally low penalty compared to similar cases. More notably, the SEC did not require Kik to offer rescission rights to investors, as it had required of other projects prior. This clearly shows an intent to ensure that the project is able to continue operating.
Thanks to the Kik case, we now have significantly greater regulatory clarity on how the SEC wants projects to conduct an ICO. This provides all projects in the crypto space a much clearer framework for how to proceed with token sales in the future if they wish to do so in compliance with SEC regulations.
To learn more about what this means for projects check out my follow-up post: How the SEC Wants you to Conduct an ICO – 3 Lessons From Kik and Telegram.
We’re about to see a fight go down that could be groundbreaking for crypto law. The popular messaging app Kik and the SEC are about to go head-to-head. SEC vs Kik.
Many legal and crypto pundits are already weighing in. So far, it would seem like the chips are being stacked with the SEC. But they might be missing some key considerations.
For this reason, I’m going to be paying close attention to this case as it continues to play out. The ruling in SEC vs Kik is going to have far-reaching implications. And if Kik is victorious, it could result in a major shift in the SEC’s approach to crypto projects altogether.
Insiders can continue to check back here as developments happen. I will be updating this article to reflect the ongoing progress of the case. If you have any comments or questions, don’t hesitate to leave them below and I will respond directly.
Table of Contents
Why is SEC vs Kik such an important case?
On its own, learning that the SEC is pursuing another unregistered ICO wouldn’t be a big deal. In fact, it would be in line with the strategy the SEC has been pursuing over the last year.
But this case is different. It’s the first time that a major project is going to step toe-to-toe with the SEC and actually have a shot of winning.
As you can imagine, this could have major implications for the wider crypto community.
The actual case is the result of the SEC targeting Kik and its “Kin” cryptocurrency. The SEC marked Kin as a security, putting it in the sight of the SEC.
And while other projects have shuttered their operations once the SEC came knocking, Kik is going all in. Backed by a billion-dollar valuation, Kik decided to lawyer up.
In spectacular fashion, Kik’s CEO announced the project’s intentions.
Ted Livingston, founder and CEO of both Kik and Kin, publicly declared his intent. It seems like Ted and the rest of the Kik team are on a mission, committing to fight the SEC in every way possible.
The company then doubled down and published its response to the SEC’s “Wells notice.” The 32-page letter served up in-depth and indisputably compelling arguments. It clearly refutes why Kin does not pass the infamous Howey Test. Meaning that Kin cannot, according to Kik’s lawyers, be classified as a security.
Now, we’re just at the beginning of this case. And how it’s going to play out is anyone’s guess.
What’s at stake in SEC vs Kik?
Let’s be clear about what this lawsuit could mean for crypto. If Kik wins, the entire game will change. Contrary to the direction of the past year, unregistered ICOs could be considered legal if they meet certain criteria.
This would also be a major blow to the SEC’s momentum. As the first ruling in favor of a crypto project, Kik would undoubtedly give confidence to other projects. This could encourage other projects to take similar stands against creeping SEC regulation.
It could also result in a shift in the way that the SEC approaches projects. Perhaps that’s wishful thinking. But a more reverent regulatory environment would be positive for the future of crypto as a whole.
Why is Kik different?
As mentioned, until now, the SEC has targeted less established projects. These smaller projects were too small to stand up for themselves. But Kik has the financial means and the willingness to fight back.
Unlike smaller projects, Kik can afford powerful legal counsel. And that is exactly what it has assembled. It has hired not one, but two of the top legal firms in the world to represent the company. These include Cooley LLC and Kirkland & Ellis LLP.
Kik is ready to spend multi-millions to fight its case, but money isn’t the only weapon it has in its arsenal.
These aren’t the actions of a company that expects to lose. And they certainly aren’t the actions of a company that’s going to simply roll over without a serious fight.
Something that might work in Kik’s favor? The SEC has been known to relax the rules when it comes to large companies, even those in crypto.
Just take a look at Ethereum. Ethereum clearly had an ICO back in 2014 that fit the SEC’s guidelines for an unregistered securities offering. But last June, at the Yahoo Finance All Markets Summit the SEC declared its digital coin ether not to be a security.
While the SEC didn’t issue an official statement, we can safely assume political reasons led the SEC to decide not to take Ethereum down.
Clearly, if you’re big enough, you can and do get special treatment.
Ostensibly, the SEC has taken a similar approach with Kik because it’s chosen only to pursue civil action, and appears to be avoiding a criminal case.
If it were dealing with a smaller company, the SEC would most likely tackle both elements. But that’s not the case here. Instead, the SEC appears reticent to arrest the CEO of the billion-dollar company. And given his demonstrated tenacity thus far, that’s probably a wise decision.
Background on the SEC’s actions: Kik just the next target on the warpath
As I’ve said in previous articles, I think most people that work for the SEC are good people. And I suspect that they genuinely want to make society better.
During my time as a corporate lawyer, I have met many SEC lawyers. They have all been smart, competent and concerned about doing things right.
But over the past few years, the SEC has gained a reputation for targeting smaller crypto and blockchain companies. And it’s unfortunate that it has decided to take this kind of approach. Such regulation directly stifles innovation and stomps on entrepreneurial ventures.
Needless to say, I haven’t agreed with the SEC’s approach to crypto regulation to date. But I do understand the difficult situation it’s faced with.
The SEC wants to protect investors, and I understand that desire fully. But, the SEC still wants to encourage efficient markets and capital formation. To say this is a tough balancing act would be an understatement.
Unfortunately, the SEC isn’t doing much of a balancing act. Its actions suggest that it is almost entirely trying to protect investors. Or, I should say its interpretation of what it means to protect investors.
When the SEC originally issued guidance, it felt like the crypto community could breathe a little easier. At least we finally knew what it was thinking.
But as many of us have come to find out, its guidance was just the first step in its pursuit. Securities offerings, investment vehicles, exchanges, and broker-dealers have all come under the regulator’s microscope. And the SEC has since systematically attacked growth and innovation.
Don’t get me wrong, the regulatory certainty that its guidance provided was needed. It even provided guidance to projects that had conducted unregistered ICOs.
In fact, the SEC offered up its action against two unregistered ICOs, AirFox and Paragon as a roadmap for other ICOs to follow as a path to compliance.
This suggested that any project that had raised money via an unregistered ICO would have to follow 4-steps:
- Pay a Penalty
- Register with the SEC
- File Quarterly and Annual Reports with the SEC
- Give its Investors Rescission Rights
But these requirements only applied if you actually raised money through an unregistered ICO. And while the SEC believes that Kik has raised money through an unregistered ICO, Kik has made a comprehensive argument that it did not.
Why is the SEC doing this?
Generally speaking, once the SEC considers a token offering to be a security offering, the company has two options:
Option #1: It can fight the decision and go bankrupt in the process.
Option #2: Give in and comply with the SEC’s hefty requirements, which could also mean bankruptcy.
Since the crypto industry is still relatively young, most companies do not have the financial means to stand up against the SEC.
Now, as we’ve discussed above, Kik isn’t your average crypto company. It has raised the war banner for all crypto companies – that’s how important the outcome of this case is. It could shift the SEC’s approach to crypto projects going forward.
When did the SEC start its war on crypto?
The SEC wasn’t always so troublesome for crypto projects. In fact, until the end of 2018, one could say that the SEC had actually done an acceptable job. It was going after bad actors without stifling innovation, balancing its competing responsibilities. This was in stark contrast to other US federal agencies that were arresting people for the “crime” of buying and selling bitcoin.
Then in late 2018, the SEC forced me to change my opinion about its approach to crypto regulation. And that was when the agency made it clear that it could not balance its conflicting mandates.
Since then, I’ve been very pessimistic about the SEC’s ability to effectively regulate crypto. Because it has proven unable to do so without killing innovation.
In the months since, we have seen a number of high profile projects come under attack from the SEC. One of the most prominent was the Basis stablecoin project. Unlike Kik, Basis’ leadership opted to walk away.
In an open letter published on its homepage, Basis’ leadership accepted the conclusion of its general counsel that the project’s supplementary bond and share tokens would inevitably be categorized as securities by the SEC.
This would have of course made them subject to the SEC’s onerous demands for registration and compliance. The cost of complying with the SEC’s demands would have been a small fortune, and it would have also severely affected the project’s activities.
As unregistered securities, the core team would have to take steps to ensure that the bond and share tokens were only made available to “accredited investors.” This would mean creating a “centralized whitelist” of acceptable investors and monitoring each transaction to make sure it matched the SEC’s specifications.
Basis did not shut down because of poor finances or poor management. It was forced out of business by rigid regulatory constraints that applied 80 year old case law to a novel technology system.
Though the SEC claims that its application of archaic rules are necessary to protect investors, it’s easy to see how overprotection can often do more harm than good. Basis’ investors were sophisticated VC’s who understood the stablecoin and wanted to put their money into the project, but they were ultimately denied the opportunity.
Again, the investors that the SEC was protecting were not unsophisticated individuals. Its backers included the “who’s who” of the VC and crypto world. Don’t believe me? Take a look at Basis’s homepage and see some of biggest names in finance listed as its investors.
You will of course have to scroll down past the notice stating that it shutdown due to overburdening regulations.
Make no mistake, I am all for SEC regulation in regards to shutting down fraudulent activity and scams. This level of oversight helps legitimize the industry while providing a gateway for institutional capital. But, I draw the line when it punishes companies for being innovative and bringing much-needed solutions to the market.
The SEC’s approach to crypto regulation is making legitimate entrepreneurs and VCs nervous as nobody wants to end up on the wrong side of an SEC investigation. But this fear either leads them to shy away from launching new projects or to move to other jurisdictions to start their businesses. Either way, the result is to severely stifle innovation in the US.
Fortunately, Kik’s leadership was brave enough to take on the challenge of fighting for the entire industry. Unlike Basis and other projects, this could be the case that the industry has been waiting for.
Did Kik conduct an unregistered ICO?
There has been a lot of commentary floating around the internet about whether Kik performed an unregistered ICO. But at this point, it’s hard to say which direction the ruling will fall.
After all, the SEC wouldn’t be pursuing the case so strongly if it didn’t think it had a chance to win. But on the other hand, fighting this case isn’t a small decision either.
Kik has already spent $5 million on negotiations with the SEC, and that’s just the beginning….
Economics aside, the real question is: Who will win the case?
Based on my assessment of the case so far, it is unclear who will win on the merits. Given that, I’m actually surprised that the SEC pursued this case at all, as it’s a major risk for the regulator should it lose.
If the SEC does prevail, it signals that the system is heavily rigged in the SEC’s favor. And not to sound too alarmist, but no project will be able to win against them. That’s a scary thought. And for the future of crypto, I hope that Kik gets a fair and open trial so it can win, as I suspect it should.
There is one other consideration, though. And that is of the emotions tied up in this case. Kik’s response to the SEC was nothing short of provocation. And that doesn’t seem to have gone down too well with the regulators.
My read on the situation is that the SEC is embarrassed. Kik’s aggressive response to the Well’s notice, forced the SEC to pursue action. In fact, it had no choice if it wanted to save face. If the SEC would have backed down, it would have looked weak. And in a burgeoning industry, at least in the eyes of the regulator, that’s something that it can’t afford.
Where does SEC vs Kik stand right now?
The SEC has officially sued Kik. This is an important milestone. It means that the regulator has concluded its investigation. And even after studying Kik’s articulate response, the regulators have decided to move forward.
In my opinion, I think this is a mistake for the SEC. But as I’ve said, it has some very smart and competent people working there. It obviously believes that it has a good case or it wouldn’t be moving forward.
Alternatively, the SEC might be playing a different strategy, which is to force Kik to cave. At this point, the SEC is preparing to make an example of Kik. It wants to set expectations for future crypto projects that come after.
With this in mind, it will look to drain Kik of its resources. If it can’t outright win, it will render the project no longer viable and force a settlement. This is the “innocent until proven broke” strategy.
That said, the SEC is less concerned with the means by which it gets Kik to submit, so long as it does. Either outcome, a settlement or a favorable ruling would be a win for the SEC. As mentioned above, Kik has already spent $5 million on the case, and it will be spending a lot more to fight this.
How will SEC vs Kik play out?
Regardless of the outcome of the case, defending it is going to be expensive and distracting for Kik. That is going to undoubtedly have implications for the founders and the project.
We’re still in the very early days of the case. So there are a lot of milestones to pass before we will be able to say how this will impact Kik longterm. In the short term, we can expect them to be in a fully defensive position.
From here, we can expect the SEC to submit litigation filings alleging that Kik violated securities laws. Kik will then file a response to those allegations, explaining why it’s not true. This will be our first look at the full take from both sides – at which time we will be able to better assess the case.
After the SEC files it’s allegations and Kik responds, the parties will go into “Discovery”. At this point, the SEC and Kik’s representation will start the process of requesting information, subpoenas, filings, summary, counter responses, and judgements to dismiss the case.
This entire process could easily take years to resolve. When this is done and the dust settles, this will be a major move on that arc to regulatory clarity for crypto projects.
What does SEC vs Kik mean for new crypto projects?
At this point, we don’t know what’s going to be the outcome of SEC vs Kik. And while I’m hopeful that Kik will be victorious, I don’t want to completely underestimate the tenacity of the SEC. With this in mind, any new projects should be keeping a close eye as this case evolves.
I’ve mentioned before that you need more than just talented engineers and marketers to help your crypto project succeed. Given the regulatory uncertainty, you need actionable legal advice to guide you.
Kik’s general counsel seems well equipped to deal with the SEC’s complaints, but even so Kik hired two of the top legal firms in the world to represent it.
The kind of guidance that seasoned legal professional offer is not just crucial when you’re going toe-to-toe with the SEC. Projects should rely on counsel for everything from signing contracts to establishing trademarks. This is especially important when dealing with specific issues like compliance and licensing.
That said, regardless of whether you do or don’t have a general counsel, it’s important that you have a basic understanding of the legal issues you’ll face. This knowledge will help you be prepared, find the best team and gear your project for success.
What does SEC vs Kik mean for Crypto Law Insiders?
The SEC has finally decided to go toe-to-toe with a capable competitor, one who has a strong case and the financial means to fight.
There is a lot on the line in SEC vs Kik, the importance of this case cannot be understated. Regardless of the outcome, the regulatory arc for crypto projects everywhere is going to be impacted.
More than that, a victorious Kik could also signal a shift in the SEC’s approach to crypto projects at large. In other words, it would set an important legal precedent that would be a turning point for crypto regulation in the United States.
But if the SEC prevails, it will prove that even well equipped companies with strong cases can’t succeed in protecting themselves against the SEC. That obviously begs the question, what chance do the little guys have?
We do not know yet how this will play out yet. But I will be keeping a close eye on this case to make sure that Insiders are kept apprised of every development.