There may a storm brewing for shady companies intent on jumping on the blockchain bandwagon. Startups with no working product seeking to raise millions, or traditional companies rebranding themselves as blockchain connoisseurs are liable to attract the ire of the U.S. Securities and Exchange Commission. In a speech delivered in Washington on Monday, SEC chairman Jay Clayton made it evident that “blockchain squatting” will no longer be tolerated.
Clayton Lays Into Bad Lawyers
The last six months have witnessed a spate of traditional companies adopting the blockchain moniker in a bid to make themselves relevant and to shore up sagging share prices. Sometimes, as in the case of Kodak, those companies have halfheartedly committed to an ICO. And at other times, as in the case of the Long Blockchain Corporation (formerly the Long Island Iced Tea Corp), there’s not even been the slightest attempt to actually do anything with blockchain technology.
In a speech delivered on Monday, SEC chairman Jay Clayton made no bones about the absolute state of the crypto space, opening his remarks by saying:
Market professionals, especially gatekeepers, need to act responsibly and hold themselves to high standards. To be blunt, from what I have seen recently, particularly in the initial coin offering (“ICO”) space, they can do better. Most disturbing to me, there are ICOs where the lawyers involved appear to be, on the one hand, assisting promoters in structuring offerings of products that have many of the key features of a securities offering, but call it an “ICO,” which sounds pretty close to an “IPO.”
Avid ICO investors, who’ve been obliged to scrutinize what passes for white papers these days, will be only too aware of the sort of legal chicanery many of these companies are prone to engaging in. Some ICOs publish their responses to the Howey Test (a means for determining whether certain transactions qualify as “investment contracts”), as if filling in a two-minute questionnaire will substitute for expert legal advice.
That sort of approach doesn’t fool Jay Clayton and his enforcers at the SEC. He continued: “Those [lesser] lawyers claim the products are not securities, and the promoters proceed without compliance with the securities laws, which deprives investors of the substantive and procedural investor protection requirements of our securities laws. Second are ICOs where the lawyers appear to have taken a step back from the key issues – including whether the “coin” is a security and whether the offering qualifies for an exemption from registration – even in circumstances where registration would likely be warranted.”
These lawyers appear to provide the “it depends” equivocal advice, rather than counseling their clients that the product they are promoting likely is a security. Their clients then proceed with the ICO without complying with the securities laws because those clients are willing to take the risk.
It’s a risky business and one that’s destined to end badly for all parties; startups, their lawyers, and investors. The SEC lacks the resources to come after every operation that is flouting securities law, preferring to focus its firepower on the low-hanging fruit: blockchain firms with no product and bold claims about future profits that are designed to artificially inflate their stock price.
“Blockchain for X” companies launching ICOs need to be especially cautious. Jay Clayton believes that many of them have been getting lousy legal advice, and his remarks this week have been interpreted as a stern but well-meaning reminder to get their affairs in order. The next time they hear from the SEC, it may be in less equanimous circumstances.
Clayton warned: “I recognize that in some ICOs there is no market professional involved. The SEC is undertaking significant efforts to educate the public that unregistered securities investments offered by unregistered promoters, with no securities lawyers or accountants on the scene, are, in a word, dangerous.”
Before moving onto other matters, the SEC chairman finished by saying: “I doubt anyone in this audience thinks it would be acceptable for a public company with no meaningful track record in pursuing the commercialization of distributed ledger or blockchain technology to (1) start to dabble in blockchain activities, (2) change its name to something like “Blockchain-R-Us,” and (3) immediately offer securities, without providing adequate disclosure to Main Street investors about those changes and the risks involved. The SEC is looking closely at the disclosures of public companies that shift their business models to capitalize on the perceived promise of distributed ledger technology.”
Despite his no-nonsense message, Jay Clayton is perceived as being broadly amenable to ICOs. He’s not trying to shut down the entire fundraising model; simply those fly-by-night operations that are solely concerned with making a fast buck. For cash-strapped startups scrimping on expenses until the ether pours in, circumventing sound legal advice is no longer an option. The ever-watchful SEC is monitoring the situation closely, and will have no qualms about taking action against the most egregious offenders.