Disclaimer: These summaries are provided for educational purposes only by Nelson Rosario and Stephen Palley. They are not legal advice. These are our opinions only, aren’t authorized by any past, present or future client or employer. Also we might change our minds. We contain multitudes.
As always, Rosario summaries are “NMR”, Palley summaries are “SDP", guest post from Drew Hinkes is "DH".
[related id=1]In the Matter of Gladius Network, LLC, SEC Administrative Proceeding №3–19004 (Order Instituting Cease and Desist Proceedings), February 20, 2019. [SDP]
Another day, another SEC token sale consent order. While these things aren’t quite an Everyday Thing just yet, the SEC’s enforcement activity in the fraught 2017/18 ICO space has shown no sign of letting up. This latest consent order reflects that. It also shows the potential benefit of working with the commission to voluntarily resolve failure to register a token that is actually probably really a security, whatever the terms and conditions said.
Before we dig into the Order, it’s worth remembering that an SEC consent order is exactly what it sounds like: the respondent (here, a corporate entity that ran an ICO) has consented to the entry of the Order and to the “undertakings” (things it has agreed with the SEC that it will do). There was no litigation. A court didn’t rule on whether or not the ICO was a securities offering. The order is not judicial precedent, though (as discussed below) it’s an indication that the SEC might go easier on people who didn’t commit outright fraud, screwed up by not registering, but came to the SEC voluntarily and worked with it to fix their problem. But, again, it’s not precedent and so far there isn’t very much of that.
The order describes the facts as follows — Gladius developed a network to rent spare bandwidth and and storage space to use to defend against cyberattacks to to enhance content delivery speed:
“The Gladius Network was to be a decentralized, peer-to-peer node network that offered internet content providers faced with a DDoS attack or increased traffic the ability to access spare bandwidth and storage space belonging to organized ‘pools’ of individuals and businesses (called “nodes”). Gladius Network participants were able to purchase the excess bandwidth and storage these pools would provide.”
As part of this, they created GLA tokens to be issued on a blockchain, and the tokens would be used as the sole currency for services on the network. Gladius raised almost $13 million worth of Ether in a fall 2017 ICO.
There was, of course, a whitepaper. And the whitepaper said that the tokens weren’t a security and that purchasers of the tokens were buying it for services:
“The Terms also stated that GLA Tokens were “not being structured or sold as securities or any other form of investment product,” and required purchasers to warrant that ownership of GLA granted access to the Gladius Network, but conferred no equity or other rights (including ownership rights) as to Gladius. Similarly, Gladius required purchasers of GLA in the ICO to warrant that their purchases were made “solely for the purpose of accessing Services . . . [and not for] any investment, speculative or other financial purposes.”
The SEC didn’t buy this, and the Order includes the SEC’s Howey analysis, in which it concludes that the token sale was an unregistered securities offering, in violation of the Securities Act of 1933.
What’s interesting about this Order isn’t really the securities analysis which is by this point — even for non-lawyers who follow the space — pretty cut and dried. People invested money with Gladius so that it could build the network and reasonably expected profits from Gladius’s managerial efforts, “whether or not they used the planned...network” and Gladius offered, sold and distributed the tokens without registration or an applicable exemption.
Realizing that they had a problem, though, Gladius “self-reported to Commission Enforcement staff. From the beginning of its discussions with Commission staff, Gladius expressed an interest in taking prompt remedial steps and complying with the federal securities laws going forward.” Instead of imposing a penalty, as it has in other cases, the consent order requires Gladius to register the tokens as a security and give investors the opportunity to get their investment back by filing a claim form.
The Block is pleased to bring you expert cryptocurrency legal analysis courtesy of Stephen Palley (@stephendpalley) and Nelson M. Rosario (@nelsonmrosario). They summarize three cryptocurrency-related cases on a weekly basis and have given The Block permission to republish their commentary and analysis in full. Part III of this week's analysis, Crypto Caselaw Minute, is above.
© 2023 The Block. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.