Guiying Ji

SEC Files First Case for ICO Regulation

On September 29, the Securities and Exchange Commission (SEC) initiated a civil enforcement action involving Initial Coin Offerings (ICO).1 In this first-of-its-kind action, the SEC alleges that Maksim Zaslavskiy and his companies, ReCoin Group Foundation and Diamond Reserve Club (DRC), fraudulently sold investors cryptocurrencies in the form of securities, which normally require registration.2

An ICO is a novel capital-raising mechanism based on cryptocurrencies: participants invest in fiat currency or a cryptocurrency, such as Bitcoin or Ethereum, in exchange for specialized cryptocurrencies, often called “tokens,” which can be sold on a secondary market or used in the future for services from the issuer.3 Startups could also create a whole new cryptocurrency and offer it for public sale to raise funds for the new business.4

The first cryptocurrency, Bitcoin, was created in 2009. As a digital money based on blockchain and an open, distributed ledger, Bitcoin maintains independence from governments and central banks.5 The most successful cryptocurrency after Bitcoin might be Ethereum, with a smart contract system that allows transactions to occur automatically once conditions are met.6 With no clear regulatory constraints, ICOs are a novel and accessible fundraising tool that have allowed a growing number of startups to raise large amounts of capital. This new unregulated funding vehicle also generates many legal concerns, including ICO scams.7

The SEC’s most significant move to regulate ICOs before REcoin involved defining a token sale by the Decentralized Autonomous Organization (DAO) as a security subject to the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act).8 The SEC categorized DAO tokens as an “investment contract” under the Howey test,9 which defines securities based on a four-part test.10 Thus, the SEC concluded the DAO violated the registration provisions of federal securities law.11 The SEC did not classify all ICOs as securities—and tokens offering utilities may not require registration—although the legal difference of the securities and utilities are not yet clear from the report.12

The recent charge against the two stock-like ICOs and their creator, Maksim Zaslavskiy, is the SEC’s first concrete action on ICOs since its July DAO report. According to the SEC, Zaslavskiy made several false representations and misleading statements in soliciting or raising funds for the nonexistent investments.13 The SEC has obtained a temporary restraining order and frozen the assets of Zaslavskiy and his companies.14

In the complaint, the SEC did not discuss why the investments offered during the REcoin and DRC ICOs constitute securities, but directly presented the arguments15 and spent considerable space presenting facts for the fraud claim. The REcoin and DRC websites have posted a notice indicating their disagreement with the SEC’s claims, stating their belief that the case is the result of “a lack of legal clarity,” and their cooperative attitude in “resolving the issue.”16 But REcoin and DRC have not yet present a more comprehensive argument about why their ICOs do not count as securities.17

After the DAO report, many cryptocurrency and blockchain proponents view increased regulation from the SEC as a necessary and positive step for a sustainable ICO market.18 From a legal perspective, investors need to fully consider regulatory implications prior to investment,19 and this first case could present a road map for ICOs to avoid registration requirements.20


GLTR Staff Member; Georgetown Law, J.D. expected 2019; Mount Holyoke College B.A. 2014. ©2018, Guiying Ji.