SEC Files Contested Complaint Over Unregistered $100 Million Initial Coin Offering, In Case That Could Clarify Application Of Registration Requirements To Cryptocurrency
Government/Regulatory Enforcement
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  • SEC Files Contested Complaint Over Unregistered $100 Million Initial Coin Offering, In Case That Could Clarify Application Of Registration Requirements To Cryptocurrency
    On June 4, 2019, the U.S. Securities and Exchange Commission (“SEC”) sued Kik Interactive Inc. (“Kik”) for conducting an unregistered offering of $100 million of digital tokens.  See U.S. Securities and Exchange Commission v. Kik Interactive Inc., No. 19-cv-5244 (S.D.N.Y. June 4, 2019).  The case has already generated substantial publicity, as Kik previously published a Wells submission it had lodged with the SEC urging against an enforcement action.  Kik has argued that the digital tokens it offered were currency, not securities, and that in any event proceeding through enforcement is improper in the face of uncertainty as to how the securities laws apply to initial coin offerings (“ICOs”).  The SEC has taken increasingly forceful positions that ICOs require registration, and this case may test the limits of its arguments. 

    Under Section 5 of the Securities Act of 1933 (“Securities Act”), it is unlawful for any person to sell or offer to sell securities into interstate commerce unless a registration statement is in effect or an exemption from registration applies.  15 U.S.C. § 77e.  From May 2017 to September 2017, Kik, a privately held Canadian corporation with offices in New York City, held an ICO whereby it offered and sold one trillion digital tokens called “Kin” to investors without filing a registration statement with the SEC.  According to the SEC, Kik used the digital coin offering to mitigate its financial problems and fund the company’s operations.  And in a sign that the offering was more akin to a securities offering than the sale of currency, the SEC alleged that Kik told investors that only a finite number of Kin tokens would be created, that the value of Kin would appreciate over time as the demand for cryptocurrency continued to grow, and that investing in Kin was an opportunity for investors to “make a ton of money.”  The SEC also alleged that Kik touted that Kin’s growth would be further driven by the Kin Ecosystem, a platform that Kik was building to facilitate the purchase of goods and services using the currency.

    According to the SEC, Kik’s ICO and related promotional events and communications constituted an offer and sale of securities under the Securities Act.  Accordingly, the SEC took the position that Kik was required to file a registration statement with the Commission and that Kik had failed to do so.  The SEC alleged that, while this violation was ongoing, 10,000 investors worldwide purchased Kin for $100 million, with over $55 million of that total coming from U.S. investors.

    While the SEC’s position is not a particular surprise (and comes on the heels of a number of settled enforcement actions staking out similar positions1), Kik has taken a notably combative position in response.  In December 2018, after the SEC indicated that it intended to recommend an enforcement action against Kik, the company responded with a Wells submission arguing that Kin is a currency rather than a “security” under federal securities laws.  And in an unusual step, Kik published its response on its website and went on something of a media tour touting its views.  Many of Kik’s legal arguments are aimed squarely at the longstanding Howey test, as articulated by the U.S. Supreme Court, for what constitutes a “security.”  See SEC v. W.J. Howey Co., 328 U.S. 293 (1946).  But Kik also asserted that the SEC did not have statutory authority to bring an enforcement action, and that Kik’s pre-sale activities and communications did not alter the analysis.  And in an appeal to the SEC’s discretion, Kik pointed out that, unlike most earlier cryptocurrency cases involving allegations of fraud,2 here the SEC argued only that Kik failed to file the requisite registration statement before conducting its ICO.  See Wells Submission of Kik Interactive Inc. and the Kin Ecosystem Foundation, HO-13388 (December 10, 2018). 

    This case thus may help to resolve critical issues in the regulation of cryptocurrencies, including whether, and under what circumstances, the securities laws apply to ICOs and related promotional activities and communications.
    1 See, e.g., Shearman & Sterling LLP, ICO Issuers Settle With The SEC Over Unregistered Coin Offerings, Need-to-Know Litigation Weekly (Nov. 20, 2018).
    2 This newsletter has previously reported on a number of these cases. See Shearman & Sterling LLP, After Second Look Judge Grants SEC Bid for Preliminary Injunction Halting Initial Coin Offering, Need-to-Know Litigation Weekly (Feb. 20, 2019); Shearman & Sterling LLP, Significant Judicial And Enforcement Developments In The Cryptocurrency Space, Need-to-Know Litigation Weekly (Sept. 18, 2018); Shearman & Sterling LLP, Criminal And Civil Charges Filed In Connection With Initial Coin Offering By Centra Tech, Need-to-Know Litigation Weekly (Apr. 10, 2018).