Over the past year, the issue of Initial Coin Offerings came to the forefront of attention of financial institutions and consumers alike. While there have been some developments on this front over the past five months, on September 29, 2017, the SEC filed its first ICO-related enforcement action, SEC v. REcoin Group Foundation, LLC, et al., No. 17 Civ. 5725, in the Eastern District of New York. This action seemingly represents the SEC’s first formal enforcement proceeding against an issuer of digital tokens.
As part of the action against Maksim Zaslavskiy and his related companies, the SEC also sought and obtained orders freezing the defendants’ assets. In the complaint related to this case, the SEC alleged that the President and sole owner of the two corporate defendants, fraudulently raised at least $300,000 related to two (2) ICOs, for which no SEC registration statements were filed (nor registration exemption applicable). Tokens issued in the ICOs were purportedly backed by investments in real estate and diamonds.
The SEC alleges, however, that neither company had any significant operations. Specifically, it seems that with respect to REcoin, Mr. Zaslavskiy allegedly claimed that the company was ready to invest the ICO proceeds in real estate, and that REcoin had raised between $2 million and $4 million, while in fact no more than $300,000 was raised. With respect to the second corporate defendant, Diamond Reserve Club, Mr. Zaslaviskiy allegedly marketed “memberships in a club” that invests in diamonds and obtains discounts with product retailers to “skirt the registration requirements of the federal securities laws.” The complaint alleges that the advertised “‘memberships’ were in all material respects identical to the ownership attributes of purchasing the purported ‘tokens’ or ‘coins,’ which are viewed as securities by the SEC. Notably, it seems that neither business entity was involved in any business operations aside from soliciting funds.
SEC took the position that the tokens that REcoin and Diamond Reserve Club purported to—but never in fact did—create or sell are in fact securities subject to their jurisdiction. The SEC further noted that the stated purpose of the tokens sold in each ICO was to acquire assets that “would generate returns for investors stemming from . . . the appreciation in value of the REcoin and Diamond tokens as the Companies’ businesses grew [due] to the managerial efforts of teams of ‘experts’.”
For any of our clients contemplating structuring, marketing, and consummating an ICO, we would like to point out that the SEC gave particular attention in this enforcement action to statements about the ICOs and tokens that appeared in the whitepaper prepared for each ICO and in social media. The SEC treated these statements as subject to Rule 10b-5 and the other anti-fraud standards imposed by the federal securities laws.