Just a couple of years ago Bitcoin and other cryptocurrencies were virtually unknown to most people. To the extent people were aware of them at all, they were seen largely as a mysterious form of money preferred for shady transactions. In the past year, Bitcoin has made headlines as an investment vehicle, though a highly volatile one. A single bitcoin was trading at nearly $20,000 in December, 2017 before plummeting to about $7,000 in February. As of April 25th, it was trading at $8,873.
Though derided by some experts as a bubble, or even a fraud, Bitcoin and other cryptocurrencies have caught the attention of Wall Street. Cryptocurrency funds have been launched and cryptocurrency futures are now traded. Respected financial market analysts now follow the cryptocurrency market.
Bitcoin and other cryptocurrencies have certain characteristics of securities, a fact that was not unnoticed by entrepreneurs looking to raise money. These entrepreneurs discovered that selling “tokens” was an efficient way to finance new ventures that, at least initially, seemed to avoid the regulatory requirements of a traditional stock offering. The first token sale, or Initial Coin Offering (ICO), was held by Mastercoin in 2013. ICOs took off in 2017, with companies raising about $6 billion via ICOs last year.
Securities regulators have taken note. According to SEC Commissioner Jay Clayton, “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.” The Commissioner warns investors, however, that “no initial coin offerings have been registered with the SEC,” and that “there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.”
In July 2017, the SEC indicated that it could have the authority to regulate ICOs under existing federal securities laws. In February 2018 the Commission announced it was launching an investigation into the cryptocurrency market.
In December 2017, the SEC issued an order stating that the tokens offered in the ICO of Munchee Inc. were in fact securities and subject to federal regulation. The company refunded investors’ money. In January, the SEC halted an allegedly fraudulent ICO that targeted retail investors to fund AriseBank, which claimed to be the world’s first “decentralized bank.” In April the SEC charged two co-founders of Centra Tech. Inc., a purported financial services start-up, with orchestrating a fraudulent ICO that raised more than $32 million from thousands of investors last year.
When offerings have gone wrong, investors have taken matters into their own hands, filing suits against the directors and officers of companies sponsoring ICOs. One of the larger actions is against founders, board members and others associated with a $232 million ICO for blockchain startup Tezos. The filing claims that the Defendants “illegally sold unqualified and unregistered securities.” Recently, investors filed a securities class action lawsuit against the owners of Paragon Coin, Inc., a startup focused on the marijuana industry, and certain of its directors and officers. The suit alleges that the company unlawfully failed to register the coins it was offering with the SEC.
The ICO suits filed so far are different from most securities class action suits filed against public companies, according to Kevin LaCroix of RT Specialty. The typical securities class action suit often cites Rule 10b-5, created under the Securities Exchange Act of 1934. The rule prohibits any act or omission that results in securities fraud. The ICO suits instead allege violation of Section 5 of the Securities Act of 1933, which requires all issuers to register non-exempt securities with the SEC.
To learn about the D&O exposures of cryptocurrencies and ICOs, join Kevin LaCroix along with Garrett Koehn of CRC Insurance Group, and Paul Tomasi of E-Risk Services, LLC for Advisen’s “Quarterly D&O Claims Webinar – Cryptocurrency Focus,” moderated by Advisen’s Jim Blinn. The webinar will be presented at 11:00 AM EDT on Tuesday, May 1.
Advisen is hosting its Cyber Risk Insights Conference in Chicago on May 22 – 23. We have a few different sessions discussing Blockchain and one of its main applications: Cryptocurrencies. One session, “Blockchain and Cryptocurrencies for Cocktail Parties”, will equip you to sound smart at cocktail parties (and understand their risks) – with a chance to practice straight after at our own conference cocktail hour! Check out the 2018 Cyber Risk Insights Conference agenda to learn more.