SEC Asserts New Virtual Currency Is Really an Unregistered Security
Commentary by Steven Lofchie
The SEC filed an emergency action against the owners and operators (the "Defendants") of a mobile messaging application, requiring them to discontinue their allegedly illegal offering of digital assets (the "Grams"). The defendants asserted that Grams are intended to be a new virtual currency and, thus, are not a "security."
In a proceeding before the U.S. District Court for the Southern District of New York, the SEC argued that it was filing the emergency action against the Defendants in order to prevent them from "flood[ing]" the United States capital markets with "billions" of Grams. According to the SEC, Grams are securities because the initial purchasers expect to profit from the Grams' eventual resale (as opposed to using them as currency). Further, the SEC argued, although the Grams are being sold to accredited investors in generally private transactions, the Defendants have not taken any steps to prevent further redistribution in the United States. As a result, the Grams would not benefit from the private placement exemption from Securities Act registration, assuming that the Grams are, in fact, "securities."
The SEC is seeking as a final judgment (i) permanent enjoinment from engaging in related acts alleged in the Complaint, (ii) disgorgement of ill-gotten gains, (iii) prohibition of further violations of certain SEC rules, and (iv) a civil money penalty pursuant to the Securities Act.
Commentary
Matt Levine, of Bloomberg, offers excellent insight about this enforcement action. For some broader context, consider this article from July on the SEC staff's issuance of a no-action letter to "Pocketful of Quarters" ("POQ"). In the POQ case, a company produced a token intended to be used in video games. The facts set out in the POQ no-action letter are distinguishable from those at issue in the Grams case in that (i) according to the letter, the video game technology was already "built" and (ii) there were strict limits on a buyer's ability to use the video game tokens (they could be spent only on video games, while the Grams are intended to be freely transferable as "currency"). Because the POQ video game technology was already built, the issuer had (in theory) a real business. Notably, the SEC permitted the token developer to use some of the proceeds from the sale of the tokens in the development of its business (the money could be used for marketing, but not for technology improvement: a restriction that makes little sense in practice).
It is not difficult to distinguish the permissible conduct in the POQ no-action letter from the arguably impermissible distribution of the Grams. That said, the POQ letter, while it is important, establishes a pretty narrow precedent. Perhaps it is now appropriate for the SEC to articulate - with more specificity - whether there is any path to the development of a cryptocurrency (other than a dollar-linked stable coin) that is not blocked by virtue of being deemed a security subject to restrictions on transfer (thereby making it useless as a currency for consumers).