SEC Charges Kik Interactive Inc. with Conducting an Unregistered ICO

Practical Law Legal Update w-020-6761 (Approx. 5 pages)

SEC Charges Kik Interactive Inc. with Conducting an Unregistered ICO

by Practical Law Corporate & Securities

Published on 06 Jun 2019 • USA (National/Federal)

The SEC sued Kik Interactive Inc. for conducting an unregistered $100 million initial coin offering (ICO).

Update: On September 30, 2020, the US District Court for the Southern District of New York granted summary judgment to the SEC (see Legal Update, SEC v. Kik Interactive Inc.: US District Court Grants Summary Judgment to SEC Regarding Unregistered ICO). The SEC and Kik later agreed on a proposed judgment, and final judgment against Kik was entered on October 21, 2020. The final judgment:

Enjoins Kik from further violations of Section 5 of the Securities Act.
Requires Kik to give the SEC notice of at least 45 days before it can participate in any digital coin or token offerings for the next three years.
Requires Kik to pay a civil penalty of $5 million.

On June 4, 2019, the SEC filed an action against Canada-based startup Kik Interactive Inc. (Kik) for conducting an unregistered $100 million initial coin offering (ICO) in 2017. The SEC claims that the tokens are securities and Kik sold the tokens to US investors without registering their offer and sale as required by federal securities laws.

In April 2019, the SEC published a framework for determining when a digital token could be considered an investment contract, and, therefore a security. Under the Howey test, an "investment contract" exists when there is an investment of money in a common enterprise with a reasonable expectation of profits to be delivered from the efforts of others. The framework focused more on the third prong of the Howey test, reasonable expectation of profits, stating that the following characteristics were especially relevant in its analysis:

Whether a purchaser is relying on the efforts of others.
Whether certain characteristics are present to determine that there was a reasonable expectation of profit, such as whether the digital asset gives the holder rights to realize gain from capital appreciation of the digital asset.
Whether other relevant considerations exist, such as whether the distributed ledger network and digital asset are fully developed and operational at the time of the token sale.

For more information, see Legal Update, SEC Publishes Framework for "Investment Contract" Analysis of Digital Assets.

According to the SEC complaint against Kik:

In a last-ditch effort to continue funding its operations, Kik offered and sold one trillion digital tokens, called Kin, between May and September 2017 without registering the sale under the Securities Act:
- Kik raised $49 million in US dollars from professional investment funds and wealthy investors selling Kin at a discounted rate through investment instruments called Simple Agreements for Future Tokens (SAFTs); and
- at the same time, Kik offered and sold Kin at a non-discounted rate to the general public in exchange for Ether, raising approximately $50 million.
Kik targeted investors and speculators in the growing cryptocurrency markets by:
- pitching Kin as an opportunity to buy low at the ICO price and sell later as increasing demand drove Kin's value higher; and
- assuring prospective investors that Kin would be able to be resold on secondary trading markets for digital assets.
Kik promised future efforts to drive an increase in Kin's value, including:
- dedicating company expertise and resources to developing and enhancing an ecosystem where Kin could be used to buy goods or services;
- compensating companies and developers that help foster transactions using Kin; and
- creating a Kin-specific "transaction service" to address flaws in existing blockchain technology.
In July 2017, several months before Kik issued its Kin tokens, the SEC published the DAO Report in which it warned that ICOs may be securities offerings and must comply with federal securities laws (see Legal Update, SEC Issues DAO Report Concluding Virtual Assets Are Securities).
When Kik distributed its Kin tokens in September 2017, Kin could not be used to buy any goods or services.

The SEC is seeking civil penalties and disgorgement of profits and ill-gotten gains.

For more information on ICOs and digital assets, see Practice Note, Security Defined and Blockchain Toolkit.

For more information on the SEC's statements and actions on ICOs, see Legal Updates:

SEC Charges Kik Interactive Inc. with Conducting an Unregistered ICO | Practical Law