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From Securities Regulation Daily, July 26, 2017

SEC cautions that digital assets offered in connection with raising capital are securities

By Brad Rosen, J.D.

The SEC has published a Report of Investigation concluding that digital tokens issued by an entity for the purpose of raising funds for projects, even when distributed ledger or blockchain technology is utilized, may be deemed to be securities under federal law. According to the SEC, such securities must be registered with the commission or eligible for an exemption from registration requirements.

ICOs and token sales. These types of offers and sales have been referred to, among other things, as "Initial Coin Offerings" or "Token Sales." Whether a particular investment transaction involves the offer or sale of a security—regardless of the terminology or technology used—will depend on the facts and circumstances, including the economic realities of the transaction.

DAO tokens. In particular, the SEC's report found that tokens offered and sold by a "virtual" organization known as "The DAO" were securities and, therefore, subject to the federal securities laws. The report also noted that those participating in unregistered offerings may also be liable for violations of the securities laws. Additionally, the securities exchanges that provide for trading in these securities must register unless they are exempt. The report also contained the familiar refrain that the purpose of the registration provisions of the federal securities laws is to ensure that investors are sold investments that include all the proper disclosures and are subject to regulatory scrutiny for investors' protection.

The SEC's report stemmed from an inquiry conducted by the agency’s enforcement division considering whether The DAO, and associated entities and individuals, violated federal securities laws in connection with unregistered offers and sales of DAO Tokens in exchange for "Ether," a virtual currency. The DAO has been described as a "crowdfunding contract" but it would not have met the requirements of the Regulation Crowdfunding exemption because, among other things, it was not a broker-dealer or a funding portal registered with the SEC and FINRA.

Carol Van Cleef, a fintech lawyer with BakerHostetler optimistically observed, "the SEC’s announcement today is not a surprise and definitely does not mark the end of the road for tokenizations. In fact it should have a very positive effect on the token market. It removes much uncertainty in the market and clarifies that the SEC will not consider all tokens to be securities. It is very consistent with the advice we have been providing to clients."

According to SEC Chairman Jay Clayton, "the SEC is studying the effects of distributed ledger and other innovative technologies and encourages market participants to engage with us". "We seek to foster innovative and beneficial ways to raise capital, while ensuring—first and foremost —that investors and our markets are protected," he added.

Corp Fin and Enforcement statement. The SEC’s Corporation Finance and Enforcement divisions provided an additional statementregarding the SEC’s report reflecting their view of digital assets. William Hinman, director of the Division of Corporation Finance further noted, "investors need the essential facts behind any investment opportunity so they can make fully informed decisions, and today's Report confirms that sponsors of offerings conducted through the use of distributed ledger or blockchain technology must comply with the securities laws."

Caution, not charges. The SEC indicated that it decided not to bring charges against The DAO or related parties in this instance or make findings of violations in the report in light of all of the facts and circumstances. Instead, the agency took the opportunity to provide specific caution to the industry and market participantsregarding the application of federal securities laws in the context of emerging distributed ledger technologies.

The SEC's investigation in this matter was conducted by members of the SEC's distributed ledger technology working group, with assistance from others in the agency's divisions of corporation finance, trading and markets, and investment management.

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