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SEC Chairman Warns Legal Advisors on ICOs
Practical Law Legal Update w-012-7922 (Approx. 5 pages)
SEC Chairman Warns Legal Advisors on ICOs
by Practical Law Corporate & Securities
| Published on 23 Jan 2018 • USA (National/Federal) |
SEC Chairman Jay Clayton expressed concerns regarding the role that legal advisors have recently been playing in the emerging market for blockchain-based initial coin offerings (ICOs), also referred to as token offerings. In addition, Chairman Clayton promised increased SEC scrutiny of public companies that shift their business models to take advantage of the perceived promise of blockchain technologies shortly before undertaking securities offerings.
On January 22, 2018, SEC Chairman Jay Clayton, in his opening remarks at the Securities Regulation Institute, described his expectations for members of the securities bar when advising companies on blockchain-based initial coin offerings (ICOs), also referred to as token offerings.
In a message to market participants that he characterized as "simple and a bit stern," Chairman Clayton highlighted two problematic scenarios regarding the legal advice given in connection with ICOs:
- Lawyers helping companies structure an ICO that has many of the key features of a securities offering while simultaneously taking the position that the product being offered is not a security and therefore is not subject to US securities laws.
- Lawyers providing equivocal advice or refusing to take a position on:
- whether the coin or token being offered in an ICO is a security; and
- whether the offering qualifies for an exemption from registration under US securities laws.
In both scenarios, Clayton said, the company typically undertakes the ICO without complying with applicable securities laws (in the first instance, with their lawyers' explicit blessing, and in the second instance, without their lawyers advising them against doing so).
Clayton went on to say that he has instructed the SEC staff to be on "high alert," not only for violations of US securities laws in connection with ICOs, but also "for approaches to ICOs that may be contrary to the spirit of our securities laws and the professional obligations of the U.S. securities bar."
The professional obligations of a lawyer practicing before the SEC are dictated, in part, by Section 307 of the Sarbanes-Oxley Act of 2002, which requires attorneys appearing or practicing before the SEC to report evidence of any material violation of an issuer. Section 307 also empowers the SEC to implement rules that give form to Section 307's reporting requirement. The SEC's implementing regulations can be found in 17 CFR Part 205. An attorney is subject to the these rules if the attorney:
- Transacts business with or before the SEC, including communications in any form.
- Represents an issuer in a proceeding or inquiry.
- Provides advice relating to the securities laws, rules, or regulations with respect to any document that the attorney is preparing or has notice that the document will be filed with or submitted to the SEC, including disclosure documents.
Under SEC Rule 102(e), the SEC has the authority to censure, suspend, or disbar lawyers who appear or practice before it who is found to:
- Not possess the requisite qualifications.
- Lack character and integrity or to have engaged in unethical or improper profession conduct (which may include intentional and knowing, reckless, and certain types of negligent conduct).
- Have willfully violated or aided and abetted any violation of the federal securities laws, rules, or regulations.
Censure, suspension, or disbarment from the securities bar may, and often does, lead to the same or similar penalties from the lawyer's state bar association.
Because the SEC is likely to closely scrutinize attorneys representing companies that undertake ICOs and may take a more expansive view than many practitioners when considering whether a coin or token is a security, attorneys advising or considering advising companies in connection with ICOs should consult, at a minimum, the SEC's recent related guidance, pronouncements, and alerts, which include:
- Statements:
- Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017), which is specifically aimed at market professionals, such as attorneys, and directs professionals to recent investigative reports and enforcement actions; and,
- Investor bulletins:
In his speech, Clayton also expressed concerns regarding recent examples of public companies that have had no prior experience with blockchain technology that have suddenly shifted their business models or changed their names shortly before offering securities "to capitalize on the perceived promise of distributed ledger technology." Counsel to public companies should be aware that the SEC will more heavily scrutinize both periodic and offering disclosures of companies that appear to be pivoting toward business models involving blockchain.
For more information on the SEC's recent statements on ICOs, see Legal Update, SEC and CFTC Issue Statements on Cryptocurrencies and Initial Coin Offerings.