The SEC’s Shutdown of the Munchee ICO

by Pillsbury Winthrop Shaw Pittman LLP

Pillsbury Winthrop Shaw Pittman LLP

Commission’s action shows the limited utility of the utility token-security token distinction.


  • Regulator finds that sellers of blockchain-based digital coins cannot dodge securities law by calling the coins “utility tokens.”
  • It is still possible to carry out an initial coin offering in compliance with the Securities Act by relying on the Act’s Rule 506(c) or Regulation A provisions.
  • There are important differences that will make one or the other of those provisions more suitable for a particular offering.

In a December 11, 2017 Administrative Proceeding, In the matter of Munchee Inc. (the Order), the U.S. Securities and Exchange Commission (SEC) shut down an ICO (initial coin offering). In doing so, it dealt a serious blow to a somewhat strained distinction relied on in many ICOs this year between “utility tokens” and “security tokens.” The Order underscores the need to develop approaches for ICOs that are compliant with the Securities Act of 1933 (the Securities Act) and highlights the risks of engaging in non-compliant ICOs.

The Munchee ICO Launch

Munchee Inc. (Munchee) is a California business that created an iPhone application to allow users to post photographs and reviews of restaurant meals. Munchee intended to sell blockchain-based digital tokens or coins (MUNs) in order to raise about $15 million to improve its application. The MUNs would be integrated into the application and used for a variety of transactions, including buying advertisements, writing reviews and selling food. After an initial marketing period, Munchee launched its ICO on October 31, 2017, but on the next day, the SEC staff called and, within hours, Munchee shut down the ICO.

A Typical ICO Path Ends in a Bad Place

As described in the Order, the steps Munchee took to launch its ICO were typical of many prior ICOs. First, on October 1, Munchee announced that it would be launching a public ICO of 500 million MUNs. Concurrently, it posted a “white paper,” which described the MUNs, the offering process, the use of proceeds, statements as to how the MUNs would increase in value and the trading market for the MUNs. Munchee then posted information about the ICO and the MUNs on its main webpage, a blog, Facebook, Twitter, BitcoinTalk and various message boards.

The distribution method was also typical. MUNs could be purchased through various websites in the U.S. and worldwide. The offering included a pre-sale in which early purchasers could buy MUNs at discounts to the offering price. Munchee planned to hold back 55 percent of the MUNS to support its business, including by paying rewards in its application with MUNs, paying its employees and advisors with MUNs and facilitating advertising transactions with MUNs. Munchee also described a two-year timeline to develop a smart contract on the Ethereum blockchain platform, which would automatically integrate “in-app” use of the MUNs and set up virtual wallets for end-users of the MUNs.

Finally, Munchee took typical steps to develop a liquid secondary market for the MUNs. The white paper stated that MUNs would be available for trading on at least one U.S.-based crypto-currency exchange within 30 days of the conclusion of the offering. It also stated that Munchee would buy or sell MUNs, as required, to ensure liquidity.

On November 1, after being contacted by the SEC staff, Munchee unilaterally terminated its ICO and the contracts of sale it had entered into with investors, and returned their funds. The SEC decided to pursue the matter. Applying the Howey test, the SEC found that the MUNs were securities and that Munchee had violated the Securities Act by selling MUNs to the public without complying with the registration requirements. In light of the prompt remedial action taken by Munchee, the SEC elected not to impose a civil penalty. Instead, it imposed a cease and desist order on any future violations of Sections 5(a) and (c) of the Securities Act by Munchee.

Wait, What? Weren’t They “Utility Tokens”?

According to the Order, Munchee’s white paper referred to the SEC’s earlier DAO Report and stated that Munchee had done a “Howey analysis.” The white paper stated that “as currently designed, the sale of MUN utility tokens does not pose a significant risk of implicating federal securities laws.” (Emphasis added). Munchee concluded that because the tokens would be used in the iPhone application that it was developing, they were “utility tokens” and not “securities.”

The SEC disagreed. The Order states, “Determining whether a transaction involves a security does not turn on labelling—such as characterizing an ICO as involving a ‘utility token’—but instead requires an assessment of ‘the economic realities underlying a transaction’” (citing Forman, 421 U.S. at 849). The SEC acknowledged that the tokens were intended to be used in the Munchee application and to buy goods or services in the future. However, it focused on how Munchee created an expectation in its ICO that the value of the MUNs would rise due to the efforts of the company in developing its application (and managing its “ecosystem”) and how investors could expect to realize a profit by selling MUNs through a liquid secondary market. These features, of course, align with the core elements of the Howey testnamely “the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”

The Myth of the Magic Frog

The Order strikes at the heart of the distinction—of which much has been madebetween a “utility token” and a “security token.” Some ICO sponsors, like Munchee, have taken the view that a token is a utility token from inception and therefore outside of the scope of the Securities Act. Others have taken a “magic frog” approach, believing that a token can begin life as a security token (i.e., a magic frog) but at the point that the application and ecosystem go “live,” the token will be transformed into a utility token (i.e., the magic frog becomes a prince) and any securities law restrictions will no longer apply. The Order clearly rejects both of these approaches. So long as investors have the opportunity to trade in the tokens with an expectation that the value of the token will increase due to the efforts of the issuer, there is a high likelihood that the token will be—and will remaina security (i.e., a plain old frog) in the eyes of the SEC.

Compliant Paths Forward

The concept of the “utility token” as a means of avoiding compliance with the Securities Act in ICO offerings has therefore been properly and decisively rejected by the SEC, but that does not mean that an ICO cannot be conducted without the full regulatory burden of a public offering registered under the Securities Act. Rule 506(c) of Regulation D and Regulation A+ under the Securities Act are particularly well-suited for ICOs. Both offer the ability to engage in broad public solicitation of investors, but there are important differences that will make one or the other more suitable for a particular offering.

The Advantages of Rule 506 and Regulation A+

Rule 506.

The most notable advantages to offerings under the SEC’s Rule 506 are that, in an offering limited to “accredited investors” (as defined in Regulation D), there are: no substantive review at either the Federal or state level; no required disclosure filings; no limit on the amount that can be raised; and, in an offering under Rule 506(c), no limit on public advertising or general solicitation.

Further, disappointed investors in a Rule 506 offering cannot sue, under the federal securities laws, for negligent misrepresentation (that is, lack of due care or due diligence). As a result of a 1995 Supreme Court decision, Gustafson v. Alloyd (513 U.S. 561 (1995)) which held that the liability provisions of Section 12(a)(2) of the Securities Act do not extend to a private sale, investors in Rule 506 offerings may assert federal claims only under section 10(b) of the Exchange Act and Rule 10b-5, which require that the investor prove actual intent to defraud, or reckless indifference to the truth of the representations made in the offering. The practical effect of Gustafson has been to make it much harder for lawsuits to be maintained by investors in Rule 506 offerings.

The most notable disadvantages of Rule 506 are (1) that offerings generally must be limited to “accredited investors,” and (2) that securities sold in a Rule 506 offering are “restricted,” which means that there are substantial barriers to the establishment of a trading market that could offer liquidity for the securities. These disadvantages are both addressed in offerings under Regulation A+, but at a substantial cost.

Regulation A+.

Regulation A was recently expanded to allow an issuer to offer and sell up to $50 million of securities over a 12-month period in a public offering, without registration under the Securities Act, leading the amended rule to be called “Regulation A+.”

The most notable advantages of Regulation A+ are (1) that the issuer can “test the waters” with potential investors for interest in an offering both before and after filing an offering statement with the SEC; (2) that the offering can be made by public advertising or general solicitation; (3) that the offering need not be limited to “accredited investors”; and (4) that the securities sold in a Regulation A+ offering will not be considered “restricted securities” under the Securities Act and will not be subject to transfer restrictions. The lack of transfer restrictions creates an opportunity for establishment of trading markets in Regulation A+ securities, offering liquidity to investors that is not available in Rule 506 offerings.

In contrast to the lack of substantive review in Rule 506 offerings, however, the offering documents in a Regulation A+ offering must be filed with, reviewed by and “qualified” by the SEC. In addition, issuers in a Regulation A+ offering may be required to provide ongoing public reporting to the SEC, which is not required of issuers in Rule 506 offerings. “Tier 1” offerings under Regulation A+ (those raising up to $20 million) also are subject to substantive review by the states. “Tier 2” offerings under Regulation A+ (those raising $20-50 million), however, are not subject to substantive review in the states. Overall, Rule 506 offers a clear advantage in its lack of substantive review of offering materials at either the Federal or state level, and in the lack of any requirement for ongoing public reporting. This lack of review or ongoing reporting should also mean that there is a significant cost advantage to proceeding under Rule 506.

In contrast to Rule 506, sellers of Regulation A+ securities also will have the risk of liability under Section 12(a)(2) of the Securities Act for offers or sales that include a materially misleading statement or omission. As noted above, this liability risk is not present in offerings made under Rule 506. As a consequence, Regulation D offerings will continue to have a significant advantage over Regulation A+ offerings in terms of risk of liability. See Can Regulation A+ Succeed Where Regulation A Failed?

            Rule 506 or Regulation A+?

Because Rule 506 and Regulation A+ both have advantages and disadvantages, there is no one answer that will be right for all offerings, but each offers a way to conduct an ICO offering in compliance with the Federal securities laws. The decision which one to use should be made only after careful consideration with securities counsel.

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.

© Pillsbury Winthrop Shaw Pittman LLP | Attorney Advertising

Written by:

Pillsbury Winthrop Shaw Pittman LLP

Pillsbury Winthrop Shaw Pittman LLP 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.