ICO Issuers Settle With The SEC Over Unregistered Coin Offerings
On November 16, 2018, the U.S. Securities and Exchange Commission (“SEC”) instituted separate settled administrative proceedings against Carrier EQ Inc., d/b/a AirFox (“AirFox”) and Paragon Coin Inc. (“Paragon”) for failing to register initial coin offerings (“ICOs”) they had conducted as securities offerings. See In the Matter of CarrierEQ, Inc., D/B/A/ AirFox, Admin Proc. File No. 3-18898 (Nov. 16, 2018); In the Matter of Paragon Coin Inc., File No. 3-18897 (Nov. 16, 2018). The actions against AirFox and Paragon mark the first time that the SEC has imposed civil penalties for standalone registration violations in connection with ICOs, and serve to reconfirm the SEC’s view that many digital tokens will constitute securities.
In August 2017, AirFox began offering and selling digital tokens on the Ethereum blockchain in an ICO. By October 2017, AirFox had allegedly raised approximately $15 million in its ICO by selling 1.06 billion tokens to more than 2,500 investors worldwide. According to the SEC, AirFox told investors that proceeds from the ICO would be used to fund a new “ecosystem” in which users could both transfer the tokens and use them to buy and sell goods and services, but had also allegedly told investors that the tokens would increase in value and would be tradable on secondary markets as the ecosystem gained prominence.
Similarly, Paragon, an online entity established to implement the Ethereum blockchain technology in the cannabis industry, offered and sold digital tokens in an ICO from August through October 2017. In a whitepaper released on its website and in posts to social media websites, Paragon outlined how it would build an ecosystem around its digital token, but according to the SEC, Paragon also told investors that the tokens would increase in value and could be traded on secondary markets. Paragon allegedly raised over $12 million through the ICO, in which over 8,000 investors purchased the tokens.
The SEC claimed that the companies violated Sections 5(a) and 5(c) of the Securities Act by offering and selling securities without filing a registration statement or qualifying for a registration exemption. The SEC found that each ICO was an offer and sale of securities under the Securities Act because each constituted the offer and sale of investment contracts in that investors who purchased the tokens had a reasonable expectation of profits from their investment based on the issuer’s efforts as a result of statements made by AirFox and Paragon. Without admitting or denying the allegations, AirFox and Paragon consented to paying a civil penalty of $250,000 each, issuing a press release notifying investors of this decision, registering the token sales as securities, and distributing claim forms to offer investors the right to rescind their investments and demand interest under Section 12(a) of the Securities Act.
Both enforcement actions mark the first time that the SEC has pursued such actions without bringing additional charges of fraud. Prior SEC orders against digital coin issuers have included allegations of fraud or other misdeeds, yet these actions only focused on registration violations. While the SEC orders did not purport to make any new law — but rather applied the longstanding Howey test to the facts of each offering to conclude they required registration — the fact that the SEC elected to bring such cases in the absence of other misconduct suggests that the SEC will continue to scrutinize any coin offering. While the civil penalties in these cases were comparatively modest, the collateral impact of such cases for issuers can be significant, particularly if investors elect to rescind their investments.