Written by Boulevard A. Aladetoyinbo
A study report confirmed that 46% of total Initial Coin Offerings (ICOs) conducted last year, which raised $104 million, can no longer boast of successful existence — they have failed. TokenData, a comprehensive ICO tracker listed 902 ICOs from 2017, 142 of this number failed at the funding stage, 276 more have failed due to some unsavory reasons. Therefore, adding up the total failure rate at 46%, and yet flowing from the study report referenced, a 59% failure rate in 2017 alone. This ICO investment space failure rate has been rationalised by advocates of ICO use as an investment vehicle in the following words: “Startups, in general, are a very risky investment, no matter the market area.”
J.R. Willett who coined the phrase “token sale”, wrote and released the first ICO whitepaper (a.k.a. “Second Bitcoin Whitepaper”) for Mastercoin (now Omni) January 2012, at a time when people threatened to set the US-SEC upon him for allegedly making an illegal security offering. Against all odds, the Mastercoin ICO raised 500,000 bitcoins, after which price jumped tenfold so that it was worth $5million at the time.
This piece discusses the liability of ICO handlers and, all those who are involved in both token launch and sale.
Liability for security token offering
The founder, co-founders and the developer team carry the full-stack liability for ICO failure as the ICO promoters and company insiders in security token offering, as distinguished from utility token offering. The reason is not far-fetched. A failed ICO, like a failed contractual agreement situation, is caused by failure of consideration, which instantly entitles token-holders to a refund of their contributions to the ICO project idea. To shed more light on this in a US-SEC-specific ICO regulation and enforcement environment:
“Review of SEC-related case law shows that liability may attach based upon an individual or company’s direct involvement in an offering. In particular, individuals or entities – including directors, officers, leading investors, public relations firms, and formally unaffiliated persons – who are directly involved with selling, issuing, or transferring shares, soliciting investors, or issuing investment materials for a particular unregistered security may be subject to the requirements of federal securities laws, and potentially held liable for violations of these laws in an SEC enforcement action.”.
This situation is not substantially different from what occurs in other jurisdictions, where the government of the nation-state involved has taken a decisive step to enforce compliance, guide and regulate unregistered virtual organisations involved in equally unregistered security token offerings. This extends to legacy companies, though registered and regulated, but involved in unregistered security token offerings. All parties involved in token launch and sale where unregistered security token is put up for sale in an investment material are caught and, may be “potentially held liable for violations” of US federal securities laws in an “SEC enforcement action”
In Singapore, a top ICO jurisdiction, security token framework is overseen by the central bank, called Monetary Authority of Singapore (“MAS”), and regulated by Securities and Futures Act (“SFA”), Financial Advisers Act (Cap. 110) (“FAA”) coupled with the bespoke guidance on ICO securities titled “A Guide to Digital Token Offerings”. The pivotal point is that an ICO only need qualify as “capital markets products” as defined under section (2)1 of the SFA.
Where an ICO platform doesn’t refund market participants, having failed in due time to show visible results from project actualisation drive, it has neglected to productively execute its roadmap. During the digital token launch and sale, this is always assumed a major influence on the token-holder to buy the network token: it would amount to a potential breach of the ICO token contract (ICO smart contract). Events like this, related scams and illicit ICO transactions led to the Chinese ban on ICOs.
The law regards the token-holder and founder/developer relationship as a contractual agreement, especially the aspect that involves a security token investment contract. Compliance with securities laws is a conditio sine qua non. Though a token contract is done in smart contract, it is yet enforceable, when complemented with a natural language contract (aka paper contract). These are enforceable agreements in the offline courtroom world.
A security token offering, as earlier noted, is distinguished from a utility token offering. While a security token offering requires registration with a securities and exchange institution, or any relevant authority, subject to certain threshold limit exceptions, utility token offerings are not subject to this strict regulation and compliance under securities law.
Security token offerings require full disclosure, investment risk analysis, among others. The securities laws would hold jointly and severally liable, the ICO promoters and outsiders who have participated one way or another in the token preparation, marketing and sale of same in the event of a flagrant violation by way of fraud, non-registration of offering and non-observance of the applicable securities laws in any material particular.
Even beyond the purview of an SEC enforcement action, the initial security token buyers can institute class actions for the recovery of contributed funds and, sizeable damages may be awarded, coupled with other civil penalties. Baker v. Dynamic Ledger Solutions, Inc. is an instructive case law on ICO securities laws and liability, though still ongoing in a US court.
Boulevard A. Aladetoyinbo, Esq is a certified blockchain lawyer.