There is no 'but it's blockchain' exemption in US Securities law

The Securities and Exchange Commission's announcement on blockchain tokens has affirmed a common sense principle: laws do not stop at a computer keyboard. This isn't a great surprise.

The SEC ruled that DAO tokens (a decentralised autonomous organisation running on Ethereum which was hacked last year) did constitute a security under US law, but that no legal action would be taken in this case.

In an accompanying Investor Bulletin the regulator said initial coin offerings (ICOs) may come under inspection on a case by case basis, regarding whether they would count as securities and require registration with the SEC.

"Case by case basis" is legal speak for 95% of the time, tweeted Preston Byrne, CIO of Monax; someone who has been outspoken against token sales of every stripe.

Another outspoken (though slightly more lenient) lawyer on the subject of token sales is Stephen D. Palley, counsel in the Washington D.C. office of Anderson Kill.

Palley said of the DAO ruling: "It will be interesting to see how the SEC deals with recent large token sales directed to US residents by US residents. The analysis could certainly be coloured by the amount of personal gain its promoters receive.

"The SEC also reminds the industry that exchanges and their participants are subject to securities laws. There is no 'but it's blockchain' or 'it's a crypto-exchange' exemption in US Securities law."

There's probably a clear division between those who think ICOs should count as securities and those who don't. Palley wanted to be clear that he does not think all tokens are securities.

"It's not only possible - it's a fact that there are software tokens in existence that are not securities." He also pointed out that the definition of ICO tokens as securities could vary from one jurisdiction to the next – a point which seems to often be ignored.

"For somebody to flat out say that all tokens are securities, my question then would be, first of all, describe the token; second of all would be, where? Because I can't tell you what the laws in Lichtenstein or Laos or Liberia would say - I don't know. One of the challenges with tokens is they can be sold everywhere in the world all at once."

Another common approach is the distinction made between a utility token and what may be a pure investment token. "I don't think that's a bad sort of general rubric if you are talking about US securities laws," said Palley.

"The fact that it's called a token or the fact that you are doing a token sale, I'm not sure that in and of itself means that it's a securities offering.

"The problem is you have people who are taking ideas, creating a website in a day, maybe writing a white paper - maybe swiping a white paper from somebody - and baldly saying if you give us your money we will build something that you can later use.

"Without going into detailed analysis of securities laws, that basic proposition: give me your capital, over which you will have no control and I will build something that you may be able to later use, and I will give you something that you can trade on secondary markets ... in a lot of places that is probably going to be a security. Period."

The consensus out in cryptoland around the SEC announcement was generally sanguine.

Ron Chernesky, investFeed CEO, said: "We welcome it, and actually think it's a step in the right direction for the industry. Before yesterday's announcement, it was common knowledge that ICOs have been enveloped in a regulatory grey area, but we spent a lot of our resources on best-in-class legal counsel and compliance to ensure we conducted ours right. One of the most telling pieces in the SEC announcement was an acknowledgement that some ICOs are completely fair investments, and some are not. We fall into the former category.

"Just like any other opportunity, there are inherent risks involved, and ICOs are no different. The SEC is warning investors to be aware of the risks, and ensure they do their due diligence on the company conducting it, the structure of the token generation event, the team behind it, and the product roadmap."

Perry Woodin, CEO of blockchain accounting and governance firm Node40, said: "Breakthrough advancements in technology often give way to rapid acceleration of new business ideas. The number of businesses supporting blockchain applications have exploded over the past couple of years, and with them we've seen new tools for raising capital.

"The issues that crop up during these cycles of rapid business acceleration often lead to individuals taking a chance with compliance. As we have seen with blockchain, those taking a position that their actions fall into a legal grey area are often shocked to find that compliance is black or white. If you're aiming for the middle ground, you will likely find yourself out of compliance and subject to existing, or yet to be defined regulations.

"The SEC's report on ICOs was not a surprise. Many of the ICOs were aiming for that compliance grey area. They wanted their offerings to be considered 'crowdfunding' even though they could not meet the requirements of the Regulation Crowdfunding exemption. Now we'll see what happens as companies attempt to fit within the SEC's guidelines."

Jaron Lukasiewicz, CEO of stealth blockchain project WRKFLOW, said: "The SEC had the ability to decimate the entire ICO market, and it has fortunately has provided open possibilities. I hope the commission takes the 'facts and circumstances' approach outlined in its report so that blockchain companies can thrive in the US.

"I don't think it's a coincidence that the SEC chose to target a German company in its investigation. The agency is signaling that its rules will apply even to non-US token issuers. Given the wide array of token functionalities, I wish the SEC had been more clear about what types of tokens might not be viewed as a security by the agency."

Steven Nerayoff, a VC, attorney, and early Ethereum advisor, said: "The SEC's decision reinforces what the blockchain industry already knew: Federal securities laws apply to all new types of technologies. If anything sold has the characteristics of a security, one must follow U.S. securities laws. This is the case for all technologies. And it should be expected that any organisation that fails to comply with the requirements of U.S. securities laws will be held responsible.

"The standard test is an investment in a business where the buyer has a reasonable expectation of profits based on the efforts of others. It should come as no surprise that the SEC found that buyers of the DAO Token purchased a security. The key feature of the DAO Token was indeed an expectation of profit if the investments made by the DAO were successful, and thus the DAO Tokens were expressly sold as an investment. Unlike a token such as Ether, the DAO token had no other utility. Many people in the industry at the time were concerned about the DAO for the reasons stated by SEC.

"Many of the token sales happening today are essentially pre-selling tokens providing access to a blockchain application or some other product, like Kickstarter. Unlike the DAO Tokens, such tokens are being sold for their utility, not as an investment.

"It must be noted that the SEC's ruling is not specific to blockchain companies or digital tokens. As the SEC developed a more nuanced understanding of this burgeoning industry, it was inevitable that it would begin to develop a body of law and interpretations surrounding it. The blockchain industry as a whole should welcome the SEC's decision as an important step towards improved regulatory guidance and clarity."

David E. Rutter, founder and CEO of R3 added: "We welcome this move by the SEC and hope regulators in other jurisdictions follow suit. Whether they trade from their bedroom or the trading floor, ICO investors are offered no protection under current regulation in most countries, yet the sheer scale of possible regulatory violations is breathtaking. Lawmakers need to get serious about how they treat these controversial, risky instruments before real people suffer serious economic harm."