Are Cryptocurrencies “Securities” Under California Law? SEC Offers Guidance
Cryptocurrencies have been in the news lately with Bitcoin reaching the $19,000 plateau in mid-December 2017. Some analysts are predicting that Bitcoin will surge even higher, though other analysts disagree. See report here. But, Bitcoin is not the only cryptocurrency. There are several competing block-chain currencies including Ethereum and Ripple (a blockchain currency launched here in California in 2012). See article from Fortune Magazine here. More to the point, many new blockchain currencies are being developed and will be offered in the near future. There is now even a term for such offerings – Initial Coin Offering (“ICO”) – tracking the idea of an Initial Public Offering (“IPO”).
So, the question arises: Does a new ICO have to comply with federal and California securities laws? Likely, the answer is yes.
California Securities Law: What is a Security?
As we wrote recently, the offering and sale of securities is governed both by federal law and California law. The applicable California law is the Corporate Securities Law of 1968 (“CSL”). See Cal. Corp. Code, §§ 25000-25707. Section 25110 of the CSL states that: “It is unlawful for any person to offer or sell in this state any security in an issuer transaction … unless such sale has been qualified … or unless such security or transaction is exempted or not subject to qualification….”
The key concept behind the idea of a security is a passive investment. Are you putting your money at risk with a business enterprise with an expectation of profit to be realized through the efforts of others? If so, very likely you have purchased a security even if you are not given a stock certificate or any physical thing called a security. See S.E.C. v. Howey Co., 328 U.S. 293 (US Supreme Court 1946).
By this definition, buying into an ICO is very likely to be considered buying into a security.
California Securities Law: New SEC Guidance on ICOs
While federal and California securities laws differ, there is an interplay between the laws and the courts and regulators take notice of actions done by their counterparts. Thus, surely the California regulators will take notice of the fact that, on December 11, 2017, the Federal Securities and Exchange Commission (“SEC”) filed enforcement actions relating to the ICOs issued by PlexCoin and Munchee, both newly launched cryptocurrencies. See here for the Complaint against PlexCoin.
Among the allegations:
- Defendants misappropriated investor funds
- Funds were raised through fraudulent and unregistered offer and sale of “securities called PlexCoin”
- The “Initial Coin Offering” made materially false statements including promising investors returns of 1,354% in less than a month
The SEC considers cryptocurrency a security at least under some circumstances and is intent on shutting down PlexCoin for violating federal securities laws. On the same day, the SEC also filed a Complaint against an ICO issued by MUNCHEE, the owner of the popular smartphone restaurant review app. MUNCHEE did not register their new cryptocurrency and is deemed in violation of the federal securities laws.
The SEC also issued a Cryptocurrency Statement on December 11, 2017. See here. Among the key points mentioned in the SEC’s Cryptocurrency Statement:
- The Supreme Court’s Howey test will inform questions of whether cryptocurrency is a security
- How new cryptocurrency is marketed matters. Is the offering/sale creating an expectation of profit from the efforts of others?
- Promises or “touting” of secondary market trading will be used to enhance the view that the new cryptocurrency is a security — the idea of “market liquidity” is often crucial to the concept of “investment” and may, again, create an expectation of profit from the efforts of others
- Has the initial offerer/seller of an ICO taken steps/made efforts with respect to the following: (i) attempting to get their new cryptocurrency “listed” on an exchange, (ii) gearing sales efforts exclusively to “investors” in cryptocurrencies and/or (iii) gearing marketing/social media in an effort to create interest among traders
The SEC made it clear that it is paying attention to the cryptocurrency phenomenon including a close watch on “bad actors.”
Contact San Diego Corporate Law
For further information, contact Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to private securities offerings/sales, the sale/purchase of businesses, and mergers and acquisitions. Contact Mr. Leonard by email or by calling (858) 483-9200.