On September 29, the United States Securities and Exchange Commission entered new territory in the regulation of ICOs, charging a businessman and two companies with fraud and the sale of unregistered securities.
The two companies, REcoin Group Foundation and DRC World (also known as Diamond Reserve Club), are both run by businessman Maksim Zaslavskiy. According to the regulatory agency’s press release (https://www.sec.gov/news/press-release/2017-185-0), the SEC alleges that the two companies’ “so-called initial coin offerings” were in fact “selling unregistered securities, and the digital tokens or coins being peddled don't really exist.”
REcoin misled investors by claiming to have a “team of lawyers, professionals, brokers, and accountants” that would oversee the company’s real estate investments, when in reality no such team existed. Further, the company claimed to have raised $2 to $4 million from investors, when in fact the company raised only $300,000.
Claiming that the US government interfered with REcoin (https://forum.bitcoin.com/recoin-f118/recoin-the-first-cryptocurrency-backed-by-real-estate-t32790-150.html), Zaslavskiy then founded DRC World. The company similarly misled investors by claiming to invest in diamonds and obtain discounts from retailers for members, when in reality the company has no business operations and has not purchased any diamonds.
Both companies raised funds through initial coin offerings.
The SEC has charged Zaslavskiy and his two companies with violations of the anti-fraud and registration provisions of federal securities laws and seeks permanent injunctions against them, as well as disgorgement plus interest and penalties. It is also seeking an officer-and-director bar and a bar from participating in any offering of digital securities against Zaslavskiy. The SEC has already obtained a court order freezing Zaslavskiy’s assets and those of his two companies.
The road to regulation
The landmark charges follow in the heels of earlier steps the SEC has taken toward the regulation of ICOs.
In response to the DAO controversy, the SEC on July 25 released an investigative report (https://www.sec.gov/litigation/investreport/34-81207.pdf) and stated in a press release that the DAO’s tokens “were securities and therefore subject to the federal securities laws” (https://www.sec.gov/news/press-release/2017-131). However, the DAO essentially got off with a slap on the wrist – although the SEC found that laws were broken, it did not file any charges.
On the same day, the SEC released an Investor Bulletin (https://www.sec.gov/oiea/investor-alerts-and-bulletins/ibcoinofferings) to raise awareness of the potential risks of investing in ICOs.
Taken together, these moves were seen as definitive evidence of the SEC’s intent to move into the regulation of ICOs.
The SEC took further steps in this direction on September 25, when it announced the creation of two new units, the Cyber Unit and the Retail Strategy Task Force, to “address cyber-based threats and protect retail investors” (https://www.sec.gov/news/press-release/2017-176). The Cyber Unit’s purview specifically includes violations involving distributed ledger technology and initial coin offerings, while the Retail Strategy Task Force has a broader mandate to “develop proactive, targeted initiatives to identify misconduct impacting retail investors.”
What does this mean for the future of ICOs?
The SEC’s moves towards a coherent set of ICO regulations may actually be a boon to the ICO ecosystem in the US.
As Fortune noted (http://fortune.com/2017/10/01/sec-ico-fraud-charges/), the SEC’s “targeted and graduated approach to regulation could help scare away fraudsters, while preserving the positive features of the technology, particularly its ability to raise funds globally with little friction and few fees.”
The SEC’s targeting of fraudsters while avoiding shutting down ICOs overall may give the technology a legal framework in which it can thrive. This, in turn, could lend the US a competitive advantage over countries such as China and South Korea that ban ICOs outright (https://blog.inwage.com/south-korea-follows-china-in-banning-icos/).