The Securities & Exchange Commission (“SEC” or the “Commission”) has made good on its promise to pursue companies that engage in what it views as unregulated offerings of securities by way of initial coin offerings or “ICOs.” Specifically, the Commission recently pursued a company called “Munchee” that created an iPhone application for people to review restaurant meals.
To fund the creation of its app, Munchee began an ICO seeking to raise $15 million and, in return, issue its token known as a “MUN.” The company issued a white paper in connection with its ICO. In that document, Munchee indicated that it believed that its tokens – the MUNs – were not securities under the long-standing securities case, SEC v. Howey, 328 U.S. 293 (1946) (describing the test to determine whether an investment contract is a security). However, as the SEC noted, Munchee did not go into any detail describing its analysis and the SEC disagreed with Munchee’s conclusion. The Commission determined that Munchee was, indeed, issuing tokens that were securities. Accordingly, the SEC filed an administrative proceeding against Munchee seeking a Cease and Desist Order on December 11, 2017 to immediately shut down the Munchee ICO.
Munchee instantly stopped its token sale and took steps to refund MUNs that had already been sold. In light of those actions, including Munchee’s quick and thorough cooperation with the SEC, the Commission did not fine Munchee, nor seek to impose any other administrative, civil or criminal remedies against the Company or its officers. The SEC made clear that the cooperation received from Munchee was important in making the decision not to pursue any further penalties.
The Cease and Desist Order against Munchee comes on the heels of the Commission’s Report of Investigation Pursuant To Section 21(a) Of The Securities Exchange Act of 1934: The DAO on July 25, 2017. In the DAO matter, the SEC sent a warning shot across the bow of the hundreds, if not thousands, of firms and companies that were pursuing unregulated ICOs. The DAO ruling essentially told the crypto-world not to ignore the securities laws of the United States and that the Howey test was/is still alive and well. While not every token will be a security, according to the SEC, issuers of tokens via an ICO must conduct a thorough and fact-based analysis in light of Howey and its progeny to determine if a security is being issued.
In Munchee, the SEC is doing what it promised in the DAO – pursuing ICOs that, it believes, are unregistered offers of securities. One of the key facts in Munchee that undoubtedly forced the SEC’s hand in the matter was that Munchee specifically stated that investors could expect their investment in MUNs to increase in value. Munchee made this point frequently in its white paper. This factor is very important in the Howey test, which states that an investment contract is a security if the purchasers of the contract (in this case, a token) have a reasonable expectation of obtaining a future profit based on a the efforts of a third party. The fact that Munchee touted the likelihood of making a profit by investing in, or purchasing, MUNs, was enough for the SEC to seek to shut down Munchee’s ICO.
While the SEC could have pursued additional penalties against Munchee, it chose not to do so because Munchee was very cooperative with the SEC, as well as diligent in returning funds to those investors that had already purchased MUNs.
This outcome should not be a surprise to anyone that has followed the announcements by the SEC over the past few months, since the DAO matter. The chair of the SEC has made it clear that he has empowered the Division of Enforcement to aggressively pursue ICOs that are not properly following the securities laws. As such, anyone considering an unregulated ICO within the United States should seriously consider seeking the advice of a legal and/or regulatory adviser to obtain some level of comfort in their decision. Certainly, there are token structures that pass muster (including utility tokens). If, however, a token has any profit/investment component to it, then it’s best to consider options other than an unregulated ICO in the United States (many of which are very palatable and are beyond the scope of this piece).
So, be careful out there. You don’t want to be the next meal for the SEC to Munch[ee] on for lunch.
Jim Falvey, JD & MBA, is a consultant with Bovill.