SEC investigation of The Dao opens a can of worms for ICOs

July 31, 2017

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The Securities and Exchange Commission issued an investigative report Wednesday cautioning market participants that offers and sales of digital assets (i.e., initial coin offerings and token sales) by "virtual" organizations are subject to the requirements of federal securities laws.

An SEC press release said that the report stems from an inquiry by the agency’s Enforcement Division into whether The DAO and associated entities and individuals violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for "Ether," a virtual currency.

The SEC Report of Investigation found that tokens offered and sold by The DAO were securities and therefore subject to federal securities laws.

The report confirms that issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies.

Securities exchanges that provide trading in these securities also must register unless they are exempt, the SEC release said.

According to the report, those participating in unregistered offerings may be liable for violations of securities laws.

The purpose of registration is to ensure that investors are sold investments that include all the proper disclosures and that are subject to regulatory scrutiny for investors' protection.

"Investors need the essential facts behind any investment opportunity so they can make fully informed decisions, and today's report confirms that sponsors of offerings conducted through the use of distributed ledger or blockchain technology must comply with the securities laws," said William Hinman, director of the division of corporation finance at the SEC.

The DAO has been described as a "crowdfunding contract" but it would not have met the requirements of the Regulation Crowdfunding exemption because, among other things, it was not a broker-dealer or a funding portal registered with the SEC and the Financial Industry Regulatory Authority, according to the release.

Whether a particular investment transaction involves the offer or sale of a security will depend on the facts and circumstances, including the "economic realities of the transaction," the SEC said.

According to the release, "in light of the facts and circumstances" surrounding its investigation of The DAO, the commission had decided not to bring charges or make findings of violations in the report. The release did not specify what facts and circumstances the were weighed in making its decision.

The SEC opted to use the investigation as an occasion to caution the industry and market participants that federal securities laws apply to those who offer and sell securities in the United States. This holds true regardless of whether the issuing entity is a traditional company or a decentralized autonomous organization; whether those securities are purchased using U.S. dollars or virtual currencies; and whether they are distributed in certificated form or through distributed ledger technology, the release said.

"The SEC is studying the effects of distributed ledger and other innovative technologies and encourages market participants to engage with us," SEC Chairman Jay Clayton said in the release. "We seek to foster innovative and beneficial ways to raise capital, while ensuring — first and foremost — that investors and our markets are protected."

The SEC Office of Investor Education and Advocacy has issued a bulletin to educate investors about ICOs. The bulletin reminds investors of red flags of investment fraud, and warns that new technologies may be used to perpetrate investment schemes that may not comply with the federal securities laws.


The SEC investigation was conducted in the New York office by members of the Distributed Ledger Technology Working Group: Pamela Sawhney; Daphna A. Waxman; and Valerie A. Szczepanik, who heads the DLTWG.

Additional assistance was provided by the agency's divisions of corporation finance, trading and markets, and investment management. The investigation was supervised by Lara Shalov Mehraban.


Topics: Regulation


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