Unlike the Environmental Protection Agency, the Securities and Exchange Commission lacks a paramilitary force. But one recent article says it’s nonetheless preparing for war. The SEC’s enemy is initial coin offerings (ICOs), a capital raising tool popular with “fintech” companies immersed in blockchain.
In a 10,000-word tome, consultant John Stark, a 20-year veteran of the SEC’s enforcement division, outlined the Commission’s battle plan. The opus included a myriad of violent and marital imagery. “Sweeps” appears eight times, along with “counteroffensives,” “well-stocked statutory armory,” “onslaught,” “dragnet,” and “blood on the floor.” One wonders if Mr. Stark is discussing a government agency or the Viet Cong.
Joining the SEC in this bloody coalition are various federal, state, and even international bodies ready to fix bayonets and charge (!) for the glory of investor protection.
Assuming Mr. Stark knows his subject, the SEC’s mobilization raising interesting questions about the role federal regulators should play at the dawn of the third internet. The agency like so much of the administrative state arose via the government-induced-and-exacerbated Great Depression.
How much should the SEC keep people from themselves and their foolhardy choices? To Mr. Stark this answer is manifest given that in the early 2000s “many investors also lost their life savings by buying into IPOs of companies encompassing little more than a sales pitch with the word “Internet” in the description.” Assuming this is true, those IPOs came with massive SEC-enforced disclosure. In America shouldn’t someone be able to risk their entire life savings on an investment that could bring gargantuan wealth? The wisdom of such risks should probably be the domain of adults smart enough to attain a life savings in the first place.
Of course, some ICO’s have not given potential investors all the available information and others have outright lied. The SEC recently charged a Brooklyn conman after allegedly lying about material facts on two ICOs. Thus far, the agency has focused on these situations.
But to Mr. Stark and many others this isn’t enough. The government should protect investors from fully disclosed and vetted opportunities. This common bureaucratic view though has a price.
As John H. Cochrane, Senior Fellow of the Stanford Institute for Economic Policy Research states:
Financial regulations are often enacted with little concrete definition, to say nothing of quantification, of their costs and benefits. Regulators and economists have little understanding of causal mechanisms that may provide benefits and incur costs. Worse, they often think they know cause and effect, either wrongly or with far more precision than they actually do, and enact regulation on the basis of unverified cause-and-effect speculation. Agencies and regulations often work at cross-purposes, one promoting what the other tries to reduce—lending to poorer and riskier borrowers, for example. Regulations stay in place long after everyone sees they are not working or are counterproductive. Regulators layer on additional rules to combat the consequences of the last round, which have their own adverse consequences.
More than ignoring the consequences of its actions, the SEC’s silence towards those trying to create SEC-compliant ICOs has worsened the situation. The agency stonewalled until July when it retroactively declared the failed DAO ICO a security and thus subject to its jurisdiction. Observers have since been forced to read into Commissioner statements for guidance.
Staff-level guidance fares no better. One seasoned securities attorney describes his recent experience:
One inquiring ICO issuer was, essentially, referred by the SEC Staff to the Howey test and told to consult further with his securities counsel.
My own recent experience, as a seasoned securities lawyer on behalf of an ICO issuer of utility tokens, did not fare much better. Yes, I prepared a detailed written analysis of my client’s “facts and circumstances,” and dutifully directed it to the SEC Staff at FinTech@sec.gov. The Staffer who eventually responded to my inquiry was thoroughly knowledgeable. Yet in the end, he was unwilling to get into “facts and circumstances,” instead directing me to the same case law which I had already reviewed.
This puts everyone in the stance of wondering if they will be on the business end of SEC artillery. One lawyer recently described being in the SEC’s crosshairs “like living in hell without dying.”
So to recap: Commissioners give off-cuff warnings when publicly asked, staff won’t say anything that could be construed as helpful and insiders direly warn of forthcoming bombardments and “sweeps.” The only people who benefit here are consultants, presumably with personal relationships on the SEC’s enforcement staff, who are available at the right price for “guidance.”
But this does little for innovators and lawyers begging for road maps to keep clients from becoming collateral damage instead of participants in a technological explosion about to reinvent 21st-century life.
Bitcoin, the basis for ICO, is not going away. It will continue to integrate into our everyday financial transactions and everyday activities. As it does, ICO will continue attracting companies involved in blockchain technology. Congress and the SEC should provide a path for SEC-compliant ICOs that will benefit the American economy and mankind.
Congress should direct the SEC to implement the following fixes for ICO companies seeking compliance:
- The SEC should integrate ICO with Reg A+ and make clear Reg A+-compliant ICOs face no other regulatory barrier. This includes waiving onerous state-level hurdles as the Treasury recommended in a recent report: “Although federal securities laws do not impose trading restrictions on [Reg A+] Tier 2 securities, state “blue sky” laws may impose registration requirements . . . state securities regulators [should] promptly update their regulations to exempt secondary trading of Tier 2 securities or, alternatively, the SEC use its authority to preempt state registration requirements for such transactions.”
- Raise the limit on Reg A+ Tier 2 to $100 million from $50 million over a 12-month period. This ensures ICOs can get the capital it needs while enduring a public qualification process.
- Reduce post raise reporting to annual instead of semi-annual. The ICO company must still report major changes but it can reduce accounting and legal fees. Given the liquidity Reg A+ provides market signals will provide investors needed information.
- Streamline broker dealer rules to allow finders and promoters to operate without fear of SEC enforcement. A “broker-dealer lite” could enhance visibility for new ICOs and speed secondary-market maturity.
These quick, pain-free fixes could ensure a smooth transition to fully SEC-compliant ICOs. US companies can continue to innovate in ways that improve all our lots. And only scam artists and cheats are ‘sent to hell without dying.’
In 10,000 words Mr. Stark dedicates one-half sentence to not stifling technological innovation. If his attitude is indicative of the SEC’s enforcement division and Congress discards its overseer role, technological advances will capitalize in Russia or London and even consultants will feel the burn.
By Jossey PLLC