The New Wild West: Beware of Fraud when Considering Your Participation in an Initial Coin Offering

With the split between Bitcoin and Bitcoin cash, and the ruling which is the subject of this post, it has been a busy few weeks in the world of crypto-currencies.

On July 25, 2017 the Securities and Exchange Commission (SEC) issued a ruling following an investigation into The Decentralized Autonomous Organization (DAO) and the initial coin offerings (ICO).

An ICO is similar to an initial public offering but it raises money from the public by selling digital tokens or coins rather than shares or debt instruments. The transactions are recorded in a blockchain and when an investor acquires digital tokens, they are granted the right to participate in activity on the blockchain, such as supporting an investment project.

The SEC believes that, in certain circumstances, as in the case of The DAO, these tokens could be considered a new form of shares and thus, should be properly registered as securities. No enforcement action has been taken against The DAO, but the ruling provided some clarification on whether digital tokens, specifically ICOs, will be considered securities in every case.

The SEC argues that unregistered ICOS, such as The DAO’s digital tokens, are risky as fraudsters may use the new technology to perpetuate investment fraud if the ICOs are not subject to federal securities laws. Stephanie Avakian, Co-Director of SEC’s Enforcement Division states, “The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets.”

Thus, along with its ruling, SEC released an investor bulletin that explains the technology behind ICOs and informs investors about the risks associated with investing in them if they are not registered as securities. Here are some excerpts from the bulletin:

  • “Fraudsters often use innovations and new technologies to perpetrate fraudulent investment schemes.  Fraudsters may entice investors by touting an ICO investment ‘opportunity’ as a way to get into this cutting-edge space, promising or guaranteeing high investment returns.  Investors should always be suspicious of jargon-laden pitches, hard sells, and promises of outsized returns.  Also, it is relatively easy for anyone to use blockchain technology to create an ICO that looks impressive, even though it might actually be a scam.”
  • “If fraud or theft results in you or the organization that issued the virtual tokens or coins losing virtual tokens, virtual currency, or fiat currency, you may have limited recovery options. Third-party wallet services, payment processors, and virtual currency exchanges that play important roles in the use of virtual currencies may be located overseas or be operating unlawfully.”

We encourage you to read the investor bulletin as purchasing digital tokens for investment is becoming increasingly common. If you are considering an investment in one of these opportunities, it is vitally important that you perform due diligence.