SEC v. Kik Interactive Inc.: US District Court Grants Summary Judgment to SEC Regarding Unregistered ICO | Practical Law

SEC v. Kik Interactive Inc.: US District Court Grants Summary Judgment to SEC Regarding Unregistered ICO | Practical Law

The US District Court for the Southern District of NY in US SEC v. Kik Interactive Inc. granted summary judgment to the SEC, ruling that Kik's two-phase initial coin offering (ICO) was an offer and sale of securities without a registration statement in violation of Section 5 of the US Securities Act of 1933.

SEC v. Kik Interactive Inc.: US District Court Grants Summary Judgment to SEC Regarding Unregistered ICO

by Practical Law Corporate & Securities
Published on 15 Oct 2020 • USA (National/Federal)
The US District Court for the Southern District of NY in US SEC v. Kik Interactive Inc. granted summary judgment to the SEC, ruling that Kik's two-phase initial coin offering (ICO) was an offer and sale of securities without a registration statement in violation of Section 5 of the US Securities Act of 1933.
On September 30, 2020, the US District Court for the Southern District of NY in US SEC v. Kik Interactive Inc. granted summary judgement to the SEC, ruling that Kik Interactive Inc.'s $100 million two-phase initial coin offering (ICO) was an offer and sale of securities without a registration statement in violation of Section 5 of the US Securities Act of 1933 (Securities Act) (U.S. S.E.C. v. Kik Interactive, Inc., (S.D.N.Y. Sept. 30, 2020)).
Update: On the consent of both the SEC and Kik, final judgment against Kik was entered on October 21, 2020. Under the terms of the final judgment, Kik is:
  • Enjoined from further violations of Section 5 of the Securities Act.
  • Required to provide the SEC with 45 days notice before participating in any digital coin or token offering for the next three years.
  • Required to pay a civil penalty of $5 million.

Background

Kik was founded in 2009 and launched a messaging application, as well as a digital currency called Kin that used the Ethereum blockchain. Kik launched Kin in two phases:
  • A private offering (pre-sale) conducted from June to September 11, 2017, which entered into simple agreements for future tokens (SAFTs) in exchange for US dollars with 50 sophisticated participants. The SAFTs provided the pre-sale participants with a right to receive Kin at a discount when the public offering became effective. Kik received $50 million through the pre-sale event, and on the last day of the pre-sale, filed Form D with the SEC claiming that the pre-sale was exempt under Rule 506(c) of Regulation D (17 C.F.R. § 230.506).
  • A public offering, called a token distribution event (TDE), which began on September 12, 2017. During the TDE, Kik sold Kin to approximately 10,000 purchasers in exchange for a total of 168,732 Ether, worth approximately $49.2 million.
On June 4, 2019, the SEC sued Kik for violations of Section 5(a) and (c) of the Securities Act based on Kik's offering and sale of securities without a registration statements or exemption from registration (see Legal Update, SEC Charges Kik Interactive Inc. with Conducting an Unregistered ICO).

Outcome

Howey Test

In April 2019, the SEC published a framework for determining when a digital token could be considered an investment contract and, therefore, a security (see Practice Note, SEC Regulation of Digital Assets: SEC Framework for Analyzing Offer and Sale of Digital Assets). According to this framework, 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.
Both the SEC and Kik agreed that the first element of the Howey test was satisfied. Judge Hellerstein ruled that the second and third element were satisfied as well, since:
  • Kik established a common enterprise by depositing funds into a single bank account and using them for operations.
  • Kik continually extolled Kin's profit-making potential, which was dependent on Kik's entrepreneurial and managerial efforts.

Integrated Offering

Kik conceded that it sold securities in the pre-sale, but it claimed that the pre-sale securities were exempt from registration under Rule 506(c) of Regulation D. The court disagreed, stating that "all sales that are part of the same Regulation D offering must meet all of the terms and conditions of Regulation D" (17 C.F.R § 230.502(a)). In order to determine whether the pre-sale was part of an integrated offering with the TDE that met the terms and conditions of Regulation D, the court considered whether:
  • The pre-sale and the TDE were part of a single plan of financing.
  • The pre-sale and the TDE both involved issuance of the same class of securities.
  • The pre-sale and the TDE were made at or about the same time.
  • The same type of consideration was received for both the pre-sale and the TDE.
  • The pre-sale and the TDE were made for the same general purpose.
The court held that all of these factors weighed in favor of characterizing the pre-sale and the TDE as an integrated transaction, with the exception of the different forms of consideration; Kik received dollars from the pre-sale and Ether from the TDE. The SEC argued that these should qualify as the same type of consideration since Ether is easily converted into dollars. The court concluded that the pre-sale and TDE were integrated as "part of a single plan of financing and made for the same general purpose," and therefore, the pre-sale and TDE constituted an unregistered offering of securities that did not qualify for exemption under Rule 506(c).
The court granted summary judgment in favor of the SEC and ruled that the parties must jointly submit a proposed judgement for injunctive and monetary relief by October 20, 2020.

Practical Implications

The Kik case is similar to the case of SEC v. Telegram Group, Inc. (448 F.Supp.3d 352 (S.D.N.Y. Mar. 24, 2020)), in which the court concluded that the initial sale and distribution of digital tokens through SAFTs, and potential resale of those tokes were part of an illegal unregistered offering of securities (see Practice Note, SEC Regulation of Digital Assets: Telegram Action).
In both cases, the court focused on the economic reality of the transactions, which led to a ruling in favor of the SEC. Together, these two cases represent a challenge for companies seeking to offer digital tokens without SEC registration. With these and other related cases, the US unregistered ICO market has been effectively shuttered and the utility of SAFTs called into question.