Another ICO issuer settles with the SEC as the long tail of enforcement continues to wag

The long tail of the SEC's ICO enforcement activity continues to wag in the form of settlements, administrative actions and lawsuits. 

This past week we saw a settlement with a fairly substantial issuer, Enigma, which raised $45 million via the sale of ENG tokens in a 2017 ICO. It's one of several instances wherein the SEC has allowed a project to survive, by not insisting on business ending remedies, and permitting the tokens to be registered.

According to the Order, Enigma sold 75 million ENG tokens to investors who were told that the funds would be used "to develop a digital asset trade-testing platform (the 'Catalyst Application') and to build a data marketplace for cryptocurrency-related data. Ultimately, as Enigma told investors, Enigma also planned to use ICO funds to develop a marketplace for other forms of data as well[.]" Investor money was used to fund the development of the platform.

The Order has a little bit of a template feel to it as if the SEC has maybe seen and settled its share of ICO cases (narrator: "it has"). And we see a couple of old tricks that apparently didn’t work as promised. Thus, for example, the fact that Enigma issued the ENG tokens through a Cayman Island subsidiary did nothing to stop the SEC from bringing an enforcement action against the Delaware-based parent corporation, Engima MPC. 

The Order recites that the tokens were investment contracts and thus securities under the Howey case and its progeny. The token sale was promoted on social media, and "[t]hey publicized the names of various 'Enigma advisors' and described their advisors' experience in the digital asset and business world, and posted a written document Enigma called a "whitepaper" that described the technology Enigma proposed to build."

Promoters were paid to tout the token sale and a bounty program was offered. The order does not mention any enforcement activity against the advisors. It would not be surprising if we see a round of settlements that address undisclosed payments for touting. Section 17(b) of the Securities Act prohibits the promotion of securities (registered or not) for pay without disclosure of the receipt of consideration. (This got DJ Khaled and Floyd Mayweather in hot water back in 2018). 

My expectation is that we'll see at least a couple of anti-touting settlements as well in the coming months, if not from this project, then from others. 

The ICO had two parts. Between June and September 2017, tokens were sold in a pre-sale through a Simple Agreement for Future Tokens ("SAFT") that was "supposed to be sold only to accredited investors." Consistent with this, the company filed a Form D with the SEC. At the end of the pre-sale, the company held a one-day "crowd sale" of the tokens that was open to the general public.

The SEC says that the tokens derived their value from the "efforts of Enigma to develop its business." Furthermore, despite the existence of an early "alpha version" of the application, they had "no consumptive use" when delivered.

As a result of all of this, the SEC says that the tokens were sold in an unregistered securities offering. To remedy the violation, the SEC says that Enigma will have to do a couple of things, of which there are three major components. 

First, the firm needs to register under the Exchange Act and file required reports to the commission. Second, it will have to provide a claim form on its website that will allow buyers to get refunds. Third, it will have to pay a $500,000 penalty. 

Now, I don't know how much money Engima has from the token sale or how much of their crypto they converted to fiat and when. But if their treasury is in a decent condition, this is a not-at-all bad resolution, and one that allows the company to survive. 

This is consistent with other SEC settlements recently, where if you're willing to pay the piper, and there is no apparent fraud involved in the issuance or use of funds, the commission will let you live to tokenize another day.

How many more will we see this year? If I were a betting man, more than you can count on your fingers and toes. This has a template-y feel to it, and it's been about two years since the peak of the ICO craze, which means that investigations for some of the larger offerings are probably reaching their end. For those in the crosshairs, either they settle, or a case gets filed.

$500,000 and some attorney fees to register doesn’t sound terrible against a $45 million raise. And historically, only a small percentage of people given the change to rescind via a claim form do so. Thus, Enigma is likely to keep most of the money it raised. 

As an aside, I know that some issuers and their lawyers are watching the Telegram case closely to see how that Court rules on the question of what a token isolation from a SAFT is. With that said, it's still only one Court and there is no guarantee that a Court in another District or Circuit – or in a state enforcement action for that matter – would follow the reasoning of a court in the Southern District of New York. 

This suggests to me that issuers who are given the chance to survive will be inclined – and probably well-advised – to take deals. I’m also a tad skeptical that a "consumptive token" that can't be consumed when it is either promised or issued (the case with the Enigma token) can easily be described as a non-security when all of the Howey characteristics are present.

Disclaimer: These are my opinions only and are not made on behalf of my past, present or future employers, partners or clients. Also, this is not legal advice. Finally, I might change my mind – I contain multitudes.