SEC’s Broad Swoop on ICOs Has Regulation-Ready tZERO in Its Sights. But Why?

March 3, 2018

The U.S. Securities and Exchange Commission (SEC) is reported to have launched a broad campaign to investigate initial coin offerings (ICOs). According to some accounts, it has recently issued a number of subpoenas to ICO entities to determine whether they are in violation of U.S. securities laws or worse — fraud. But if that’s the case, why is seemingly regulation-friendly platform tZERO included? 

Also see: Bank of England’s Mark Carney Is Just the Latest Establishment Figure to Trash Bitcoin’s Regulation-Friendly tZERO Targeted

With investments in ICOs now exceeding $1.5 billion USD per month, the ongoing $250 million tZERO ICO has been included in the SEC swoop. tZERO is a subsidiary of, and is seeking to raise funding for its security token trading system. Launched December 18th last year, it attracted a whopping $100 million within the first 12 hours.

Acknowledging the inevitability of regulation in its whitepaper, tZERO claims to be the first ICO to comply, pre-emptively, with securities regulations:

“The tZERO token is the first preferred stock security token of which we are aware, and the tZERO token is being issued in accordance with applicable U.S. federal and state securities laws”.

The members of the tZERO team have backgrounds steeped in trading technology, securities, and securities regulations. Furthermore, Overstock was the first major online retailer to dip its toes into cryptocurrency, accepting bitcoin as far back as 2014. Last year, it integrated ShapeShift to start accepting altcoins.

What Is the SEC’s Problem?

The SEC issued the so-called ‘The DAO Report’ in July last year. In the report, the Commission outlined a determination that the Howey Test would be applied when deciding whether or not tokens offered during an ICO would be deemed securities, and therefore subject to securities regulations at both the state and federal levels.

The Howey Test defines an instrument offered when raising funds to be an “investment contract for the purposes of the Securities Act” if it is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise”. The Howey Test, then, deems tokens issued by an ICO to be securities.

To avoid being deemed to be issuing securities, ICO projects offered “utility” tokens, i.e. tokens that do not represent equity in an enterprise, but units of services that could be utilized and purchased. This would avail the issuing ICO an exemption to securities classification. They would not face the burdensome regulatory requirements traditional securities issuers face. And their investors would not be afforded the protections SEC oversight ordinarily provides them.

The Devil Is in the Detail

If tZERO is regulation compliant, why do they find themselves in the SEC’s crosshairs? Fine print. As stated above, the tZERO whitepaper claims to be the first ICO to issue “preferred stock security tokens… in accordance with… securities laws”, presumably providing the same rights and protections of traditional securities, as well as the benefits – simplicity and utility – of the tokens commonly issued in an ICO.

Their fine print, however, reads slightly differently:

“tZERO Tokens when offered and sold will not be registered under the U.S. Securities Act of 1933 (the “Securities Act”), the securities laws of any state, or any other jurisdiction, nor is such registration contemplated. tZERO Tokens will be offered and sold pursuant to one or more exemptions from the registration requirements of the Securities Act and any other applicable jurisdiction”.

While exempted securities are theoretically issued in accordance with securities laws, the fine print does conflict with the tone and spirit of the whitepaper. Once again, caveat emptor. Investors need to conduct their own due diligence before investing in ICOs. That includes reading the fine print.

What’s your take? Is the SEC clampdown too burdensome on innovation? Or should ICOs be held to higher levels of accountability?

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