The Securities and Exchange Commission (“SEC”) has taken a strong stance in enforcing securities laws over initial coin offerings (“ICOs”), which have recently become increasingly common as a way to fund startups. Approximately $3.8 billion have been invested in ICOs to date, but no ICOs have been registered with the SEC.

Last week, the SEC terminated an initial coin offering by a restaurant review app, Munchee, because it had not been properly registered. Munchee planned to raise $15 million by selling “MUN tokens,” a custom cryptocurrency.  According to the SEC, since investors could reasonably expect a return on investment in MUN tokens, the offering was subject to SEC registration rules.  Previously, some companies argued that ICOs are not subject to securities laws if the cryptocurrency is structured to provide a “utility.” For example, MUN tokens could be earned by users for writing reviews, and may eventually be utilized to purchase meals as well as advertising on the app. SEC Chairman Jay Clayton has said that merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security. The SEC has indicated that a token can be a security based on the long-standing facts and circumstances test, which includes assessing whether investors’ profits are to be derived from the managerial and entrepreneurial efforts of others. Even though MUN tokens provided some utility, they ultimately qualify as securities.  Since the Munchee offering had not been properly registered with the SEC, Munchee halted the ICO and returned proceeds to investors. The SEC declined to impose a penalty, in part because of Munchee’s quick response.

There are concerns that the unregulated ICO market provides opportunities for investor fraud and manipulation, especially given the extent to which cryptocurrency has recently captured the public interest. Shortly after the Munchee enforcement action, Chairman Clayton released a statement warning “Main Street” investors about trusting ICOs without determining whether they comply with securities laws. Regulators in China and South Korea have recently banned such offerings outright. The SEC formed a new unit in September to target securities misconduct involving distributed ledger or “blockchain” technology, and will likely continue to provide guidance for ICOs with enforcement actions. The SEC has indicated that it will remain vigilant to identify improper offerings that seek to sell securities to the general public without the required registration or exemption.