SEC Brings First Enforcement Action Related to Initial Coin Offerings

by Jones Day

Jones Day

In Short

The Situation: Promoters of two recent initial coin offerings face charges of investor fraud brought by the SEC, after allegedly misrepresenting the assets purportedly backing the offerings, exaggerating the amount of funds already raised, and falsifying information relating to an advisory team involved in the process.

The Result: This is the SEC's first enforcement action relating to initial coin offerings and confirms that its commitment to protecting investors from fraud remains the same, regardless of the technologies involved and the means of raising capital.

Looking Ahead: Initial coin offerings should continue to be viewed as a valid process for raising capital, but promoters, investors, and other stakeholders should also be aware that the marketplace is being carefully monitored in an effort to protect investors.

The popularity of initial coin offerings ("ICOs") has grown significantly in 2017. This year alone, roughly the equivalent of US$2 billion in capital has been raised through ICOs. In an apparent attempt to stand out in a crowded field, the promoters of a recent pair of ICOs—REcoin and Diamond Reserve Club ("DRC")—got creative with their marketing materials, alluding to Led Zeppelin's iconic 1976 album The Song Remains the Same to highlight the purported benefits and opportunities that accompanied the coins.

While the musical allusion was dubious in the context of the REcoin and DRC ICOs, one could easily apply it to the enforcement activities of the U.S Securities and Exchange Commission: Although technologies and capital raising schemes may change, the SEC's mandate to protect investors from fraud remains the same.

Consistent with this mission, the SEC late last month charged the promoters of the REcoin and DRC ICOs with defrauding investors, marking the first time the SEC has brought an enforcement action related to ICOs. In a suit filed in the U.S. District Court for the Eastern District of New York, the SEC alleged that the defendants illegally offered unregistered securities and made fraudulent misstatements that were designed to deceive investors in connection with the ICOs.

Among other things, the SEC alleged that the defendants fraudulently raised US$300,000 from hundreds of investors by falsely touting that the REcoin offering was backed by investments in real estate and the DRC offering was backed by diamonds. In reality, the defendants never purchased any real estate or diamonds, the complaint said. What's more, the coins themselves did not even exist; individuals who invested in the coins received nothing in return.

The SEC also alleged that the defendants tried to boost interest in the offerings by claiming that the two ICOs had successfully raised millions of dollars, when in fact they had raised only a fraction of that amount. In addition, the defendants allegedly sought to reassure investors by claiming that experienced lawyers, developers, experts, and brokers were advising the companies throughout the process. The SEC contends that no such team of advisers existed.

Also, according to the complaint, the defendants described their offerings as "Initial Membership Offerings," to distinguish them from ICOs in an effort to avoid having the coins designated as securities. But the SEC alleged that the distinction was a "sham" and pointed to the marketing literature for the ICOs as evidence that the coins are in fact securities and subject to the registration requirements of the federal securities laws.

Because the ICOs were ongoing when the complaint was filed, the SEC sought emergency relief and obtained an order freezing the defendants' assets. In addition, the SEC has asked the court for permanent injunctions and disgorgement, plus interest and penalties. It also is seeking to bar the individual businessman behind the alleged scheme from ever serving as an officer or director of a public company and from participating in any offering of digital securities.

This enforcement action follows a raft of guidance from the SEC over the past several months. As we previously reported, in July, the SEC issued an investigative report ("DAO Report") to warn market participants that "virtual coins or tokens may be securities and subject to the federal securities laws." In August, the SEC issued an investor alert regarding potential scams involving companies using ICOs in pump-and-dump schemes. Likewise, the SEC suspended trading in the common stock of several issuers due to concerns regarding statements about their plans for ICOs. In early September, an SEC co-director of enforcement reportedly warned about fraudulent coin offerings at a panel discussion in New York.

The recent enforcement action concerning REcoin and DRC reinforces this guidance and also reminds market participants of several key lessons:

  • According to the DAO Report, whether a coin is a security depends on the facts and circumstances of the offering, including the economic realities of the transaction, not on labels that are applied. The mere fact that the REcoin and DRC offerings were marketed as memberships in a club, as opposed to an ICO, did not change their fundamental nature or exempt them from securities laws.
  • ICOs that are marketed as investment opportunities or tout the potential for returns on an investor's capital very likely are securities that should be registered with the SEC, unless an exemption applies. Information about registered offerings can be found on the SEC's website.
  • Promoters of ICOs should take care with how they describe their offerings and the rights that accompany the coins they are issuing. White papers and other offering documents should clearly explain the business model and risks associated with the project.
  • Promoters of ICOs should consult with experienced securities counsel regarding how to structure their ICOs so they are compliant with federal and state securities laws. Promoters may also need to consult with lawyers from international jurisdictions if they intend to target investors globally.

Going forward, expect the SEC to scrutinize other ICOs for potential securities law violations and to bring more enforcement actions. In the near term, the SEC likely will focus on the most egregious examples of fraudulent conduct, such as what allegedly occurred in the REcoin and DRC offerings. As it does so, market participants will gain more clarity about the SEC's enforcement priorities in this space.

Despite the SEC's increased attention to ICOs, companies seeking to use them to raise capital should not lose hope. Proper ICOs can be a legitimate means of raising funds from investors in the United States and could give birth to promising companies. Even so, market participants should bear in mind that the SEC is carefully monitoring the ICO marketplace so that it can continue to fulfill its role of protecting investors from bad actors.

Three Key Takeaways

  1. This first enforcement action confirms the SEC's approach will be to look at the substance of any offering rather than the way it is described when assessing classification and/or regulatory compliance.
  2. Guidance previously provided by the SEC advises coin promoters to seek experienced securities counsel to ensure they stay compliant with federal and state laws.
  3. Promoters and investors should expect the SEC to scrutinize future offerings for potential securities law violations, possibly leading to additional enforcement actions.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Jones Day | Attorney Advertising

Written by:

Jones Day

Jones Day on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.