SEC issues cease-and-desist orders for unregistered token presales and anti-touting violations.
Not content to let the dog days of summer slip by, the US Securities and Exchange Commission (SEC) recently issued two cease-and-desist orders relating to the offer, sale, and marketing of cryptocurrencies.
SimplyVital – Simply Saying a Sale Is Exempt Will Not Suffice
In the first order (SV Order), the SEC concluded that SimplyVital Health, Inc. (SimplyVital), a “health care-related blockchain ecosystem” start-up, violated the Securities Act of 1933 (Securities Act) by failing to register an initial coin offering (ICO) presale.
As part of the company’s development of the “Health Nexus” blockchain ecosystem, SimplyVital planned to raise capital by selling a native token, HLTH, through a “presale” and public ICO. SimplyVital’s legal counsel prepared an offering memorandum that stated that, for the offer and sale of HLTH, SimplyVital was seeking to rely on Section 4(a)(2) of the Securities Act and the Regulation D or Regulation S safe harbor. During the presale, participants paid Ether to SimplyVital in exchange for the right to receive HLTH once minted, pursuant to a simple agreement for future tokens (SAFT). By mid-2018, SimplyVital had raised the equivalent of US$6.3 million, mostly from individuals and ICO pools ― which are “groups of investors that pooled their money to collectively satisfy a token or coin issuer’s investment minimum and to take advantage of discounts offered to pre-sale investors.”
The SV Order reports that even though SimplyVital was aware of the participation of ICO pools in the presale, “SimplyVital failed to take reasonable steps to verify that purchasers of securities sold in its pre-sale offering were accredited investors.” As a result, SimplyVital’s presale of HLTH (an acknowledged securities offering) did not qualify for an exemption from registration. After being approached by the SEC following the presale close, SimplyVital decided not to move forward with the public ICO or to mint or deliver any HLTH. Thereafter, SimplyVital announced it was shelving development of Health Nexus and returned funds to investors that participated in the presale.
Although the fact pattern appears routine, the SV Order offers two takeaways for market participants:
- Private placements of securities must adhere to the requirements of the relevant exemption. In this case, the SEC faulted SimplyVital for failing to verify that only accredited investors were participating in the presale through the ICO pools. These ICO pools were a form of special purpose vehicle (SPV) that either needed to be accredited investors on their own, or each investor in the SPV accredited investor, and SimplyVital failed to verify these facts.
- The SEC may show leniency to Securities Act violators who voluntarily seek to remediate investor losses. Although SimplyVital’s return of nearly all presale proceeds did not provide regulatory absolution, the SEC cited the return in the decision not to impose civil or criminal fines. The disposition in this matter also stands in stark contrast to the criminal and civil complaints brought against issuers that allegedly absconded with ICO proceeds raised in fly-by-night frauds.
ICO Rating – A Story of Anti-Touting Flouting
In the second order (Rating Order), the SEC announced a settlement (including civil penalty) with ICO Rating, a Russian corporation, for violations of Section 17(b) of the Securities Act.
The Rating Order states that from December 2017 to July 2018, ICO Rating claimed to produce independent analysis, research, and ratings regarding security tokens offered in ICOs, but in reality the company was receiving compensation from many of the issuers under evaluation. The Securities Act requires those who publish information about securities to disclose any compensation received from the security issuer so that market participants may weigh the reliability of the information. ICO Rating failed to make such disclosure, leading potential investors to believe they were receiving unbiased research rather than paid promotional content.
The SEC sent a clear message to the market with this action: those who research, rate, and promote securities ― much like those who sell or intermediate securities ― must comply with the securities laws “regardless of whether the securities being touted are issued using traditional certificates or on the blockchain.”