The calm before the storm
The coming crackdown on ICOs
In the last two weeks there have been a couple of events worth noticing. The first went by almost unnoticed and did not spark the interest and comments that it should have. The second just happened on May 3rd and will probably start raising some attention in the next few days if and when people will digest its implications.
The first event is the speech made by former CFTC Chairman Gary Gensler at the MIT Technology Review Business of Blockchain on April 23. Gensler backed the SEC stance on ICOs saying that “Many initial coin offerings, probably well over a thousand, many crypto exchanges, probably 100 to 200, are basically operating outside of US law”. He added that he expects that “2018 is the year to start bringing into compliance this sort of 1000 plus tokens” and that “when and not if, is the only question”.
He added that except for bitcoin, bitcoin-cash and litecoin (which are not securities), also Ripple, Ethereum, NEO and EOS may very well be considered securities.
The second event took place on May 3rd and it is a class action lawsuit filed against XRP II LLC, Ripple Labs and its CEO Garlinghouse for the alleged unregistered sale and offer of securities in violations of the US Securities Act and the California Corporate Code.
I will not comment on the legal aspects of the lawsuit, what is important here is to understand what this means for the sector.
There are two aspects to it: the first is what the regulators will do and the second is what are the practical consequences of the regulator’s actions.
On the first aspect the SEC has many ways to tackle the issue — from the lightest to the more draconian — such as trying to enforce compliance of those “1000 plus ICOs” retroactively, obtain disgorgement of any money or proceeds of the illegal activity, impose civil penalties against exchanges, promoters, advisors or anyone who sold or even evangelized those ICOs. All this without even considering the independent criminal proceedings which may be brought by the DOJ and the individual U.S. Attorney’s offices.
Even if this concerns mainly US based ICOs, also EU based ICOs can not sleep “sweet dreams” because (i) it is not clear how the EU regulators will act and if they will follow on the SEC steps and (ii) it is sufficient that only 1 US citizen bought a token and then even a Gibraltar or Malta based ICOs will start feeling the pressure of US authorities which are well known for their — mostly illegal — extraterritorial overreach (just ask the Swiss bankers about it).
The coming crackdown is however only one side of the coin which everyone is looking at, but it is by no means the most important nor the one that may have the heaviest implications for the market.
The second aspect is likely far more important and it is indeed the avalanche of lawsuits that the regulators´ approach will trigger. Every disgruntled investor who has suffered losses is now legitimate to sue and get his money back because the ICOs did not comply with applicable Securities laws.
Of course this is not the first class action lawsuit against ICOs — in addition to Tezos I could count five being filed between the end of 2017 and the beginning of the year — Centra, Monkey Capital, ABT Coin, Giga Watt and Paragon Coin. But what is here relevant is the acceleration of the trend and the timing between Gensler´s talking about Ripple being a security and the lawsuit. Therefore this lawsuit may signal the acceleration of a trend that will have — quoting Gensler´s words — “a chilling effect on this frothy ICO market”. Also note that, even if EU regulators did not take a clear stand like the SEC, they also did not legitimate ICOs (except Switzerland, Gibraltar or Malta), therefore an EU based ICO runs the same risks that token buyers may sue arguing that the token is effectively a security under EU Laws and the issuer failed to comply with EU Securities laws.
The impression is that the industry is taking those events too lightly and it is not preparing nor planning for the problems to come. Those “1000 plus ICOs”, should set up crisis management teams to evaluate the legal risks that they are exposed to and what measures they will have to take to reduce — as much as possible — the damages. The consumer industry does it routinely with product liability issues because they know that if left unchecked the risks will be too high for the business. Some suggested a sort of Amnesty process to be negotiated with the SEC. Unfortunately, not much seems yet to be happening. The ICO industry is too young, the players are relatively inexperienced and likely inebriated by the quick riches and easy success.
For better or worse it will not last and this may well be the last calm before the storm.