On September 29, 2017, the SEC filed its first ICO-related enforcement action, SEC v. REcoin Group Foundation, LLC, et al., No. 17 Civ. 5725, in the Eastern District of New York. This represents the SEC's first formal enforcement proceeding against an issuer of digital tokens. As part of the action against Maksim Zaslavskiy and his related companies, the SEC also sought and obtained orders freezing the defendants' assets. (Although the SEC has previously announced its investigation of The DAO, this earlier announcement took the form of a more rarely used "Report of Investigation" pursuant to Section 21(a) of the Securities Exchange Act, and expressly disavowed any enforcement action. See our prior blog post on this investigation.)

In the REcoin Group Foundation complaint, the SEC alleges that Maksim Zaslavskiy, the President and sole owner of the two corporate defendants, fraudulently raised at least $300,000 related to two ICOs, for which no SEC registration statements were filed (nor registration exemption applicable). Tokens issued in the ICOs were purportedly backed by investments in real estate and diamonds. The SEC alleges, however, that neither company had any significant operations. Specifically:

  • With respect to his first ICO via REcoin, Zaslavskiy allegedly claimed that the company had "a team of lawyers, professionals, brokers and accountants" ready to invest the ICO proceeds in real estate, and that REcoin had raised between $2 million and $4 million. According to the SEC complaint, however, REcoin had raised a total of approximately $300,000 and had no such professionals consulting or working for REcoin.
  • With respect to the second corporate defendant, Diamond Reserve Club, Zaslaviskiy allegedly marketed "memberships in a club" that invests in diamonds and obtains discounts with product retailers. The Complaint contends that this ICO was structured as a sale of "memberships in a club" in order to "skirt the registration requirements of the federal securities laws," but maintains that the "'memberships' are in all material respects identical to the ownership attributes of purchasing the purported 'tokens' or 'coins' and are securities." The SEC further alleges that, despite the representations, Diamond Reserve Club has not purchased any diamonds nor engaged in any business operations.

In taking the view that the tokens that REcoin and Diamond Reserve Club purported to—but never in fact did—create or sell are securities subject to their jurisdiction, the SEC specifically noted that the stated purpose of the tokens sold in each ICO was to acquire assets that "would generate returns for investors stemming from . . . the appreciation in value of the REcoin and Diamond tokens as the Companies' businesses grew [due] to the managerial efforts of teams of 'experts'." Without expressly acknowledging it, the SEC appeared to be referring to one of the key prongs of the Supreme Court's Howey test for when an arrangement can be characterized as an "investment contract," and thus is a "security," for purposes of the U.S. federal securities laws. The SEC also observed that the defendants themselves strongly supported this conclusion, when they stated that "ICO coins (tokens) are similar to shares of a company sold to investors in an Initial Public Offering (IPO) transaction."

Anyone contemplating structuring, marketing, and consummating an ICO should note that the SEC gave particular attention in this enforcement action to statements about the ICOs and tokens that appeared in the whitepaper prepared for each ICO and in social media. The SEC treated these statements as subject to Rule 10b-5 and the other anti-fraud standards imposed by the federal securities laws.

Since issuing its inaugural guidance on The DAO toward the end of July 2017, the SEC enforcement staff has demonstrated its intense focus on the burgeoning and active ICO market. SEC v. REcoin is the first but likely not the last enforcement action the Staff will take in this area.

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