Many new projects are placing themselves in a precarious legal position as they rush to launch their ICO. That’s because legal time bombs are waiting to explode across their ICO marketing communications.
Unbeknownst to many founders, these are right there for all to see. On Facebook, LinkedIn, Twitter, Telegram, and Slack, marketing messages may be breaking several laws that could lead to civil and even criminal charges. The problem has to do with language, and how an ICO is marketed.
While there are many legal aspects to consider when launching an ICO, the most significant concern for most projects is whether or not their token falls under securities laws. There are two paths a project can take –
Your token is a registered security offering
Let’s say your project has established that its token is a security and you register with the relevant authorities. Are you sure your project’s marketing communications are not violating any securities laws relating to marketing activities?
Securities regulations in most jurisdictions apply to more than just how a security is issued and who can participate. They also apply to how you can market your offering. Non-compliance can lead to civil and criminal charges, so your project needs to be careful about the language used across all marketing communications including social media posts, whitepapers, terms, and conditions, etc.
In the US, for example, when marketing a security, issuers are prohibited from resorting to techniques that create unrealistic investor expectations or language that may mislead potential investors.
Remember Tezos? The project is fighting several legal battles. They are the subject to four separate class-action lawsuits (at last count). Plaintiffs are asking for a refund as well as damages primarily due to the selling of unregistered securities but also because of false representations made by the project and the failure to disclose critical details relating to the timeline of the project.
Look at the excerpt below from the second lawsuit. It accuses the Tezos Foundation of fraudulently and deceptively marketing the sale of the platform’s native token “Tezzies” as charitable contributions. The complaint states,
“Notwithstanding the defendants’ attempts to avoid governmental and private scrutiny, it is clear that the financiers were indeed profit-seeking investors in a security and that defendants promoted and conducted an unregistered offering of securities, not a charitable fundraiser.”
But ICO marketing communications under securities regulations concern more than just the language used to promote a project. They can also dictate what information must be disclosed in public communications. Section 5 of the Securities Act of 1933, for example, requires full and fair disclosure of all material information for an investor to make an informed investment decision, including information about the issuer’s financial condition, management and many other details.
Beyond these issues, there are multi-jurisdictional considerations to take into account. Marketing an ICO in different countries may put your project at risk of breaking laws in other jurisdictions. The fact that local authorities in your jurisdiction have certain requirements doesn’t mean that regulators in other countries play by the same rules.
Even states can have different laws. A project that is US-based, for example, will additionally need to adhere to blue sky laws. And don’t forget about other sets of laws concerning deceptive and unfair practices in marketing and advertising that are independent of securities regulations.
Your token is not a registered security offering
If you have not formally registered as a security, or qualified for an exemption, and believe that you are offering a utility based token, things begin to get more complex.
Your ICO marketing communications could be used by authorities to determine whether the token you’re offering should actually classify as a security.
If your project is promoting your token as a way to make money, then you are in fact promoting a security by SEC and most other standards around the world. It doesn’t matter that your token has an element of utility. Utility tokens that include an investment component are often classified as securities.
According to the Howey Test, an “investment contract” exists if an investor expects profits from the investment.
“A security is “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”
Furthermore, utility tokens that are issued before they can be used on a platform also have a high chance of getting classified as securities. Why? This memo from Wilson Sonsini Goodrich & Rosati explains –
“Tokens that are issued before they can be used generally are securities, even if eventually they may not be securities. In these cases, the value of the tokens at the time they are issued typically is largely dependent upon the sponsor of the tokens to develop and market the tokens and the platform on which the tokens will be used. This type of “reliance on the efforts of others” is a hallmark of determining when an instrument (like a token) is a security.”
So, unless your token offering is 100% utility and can be used at the time of your ICO, it will likely be deemed a security. The SEC shut down Munchee, a company that conducted a $15 million token sale, sighting among other things, that the company had presented itself as a “utility” token but was, in fact, a security.
The company violated sections 5(a) and 5(c) of the Securities Act by offering and selling these securities without having a registration statement filed. The company marketed their offering with misleading statements and promised investments returns, a hallmark of a security.
In the cease and desist order under section 8A of The Securities Act of 1933’ against Munchee, the SEC laid out their case that MUN tokens were securities. Many of their arguments were based on the fact that Munchee’s public marketing efforts and materials had misled investors into having a “ reasonable expectation of obtaining a future profit.”
Here’s an excerpt from the filing.
“Munchee made public statements or endorsed other people’s public statements that touted the opportunity to profit. For example, on or about October 25, 2017, Munchee created a public posting on Facebook, linked to a third-party YouTube video, and wrote “199% GAINS on MUN token at ICO price! Sign up for PRE-SALE NOW!”
The company posted a blog post on October 30, 2017, titled “7 Reasons You Need To Join The Munchee Token Generation Event.” Reason 4 stated, “As more users get on the platform, the more valuable your MUN tokens will become”.
The bottom line –
Just calling something a “utility token” does not protect you from securities laws in most jurisdictions. Regulators will look beyond these types of labels and study your offering more closely. Part of this will include an examination of your marketing materials which may provide evidence that shows your project is offering a security but also deliver a litany of examples where it broke laws relating to how securities can be marketed.
Don’t forget. Even if you’re ICO offers a genuine utility token, you are still at risk of breaking laws in other jurisdictions where you market and could also be guilty of violating separate sets of regulations relating to deceptive marketing practices as well.
How to reduce your risks
Educate your team
Build a compliance culture inside your organization. To do this, you will need your team to get educated on the particulars of your ICO as well as the marketing/ advertising laws relating to it.
Of course, something might go wrong. Let’s say, for example, one of your team members sends a marketing communication to your Facebook community with misleading claims. Your project can alleviate the potential legal impact of this type of mistake, by keeping training records in case the authorities come knocking at your door. If you can show a history of staff training and company guidelines relating to marketing communications, there is a chance authorities will be lenient.
Don’t use investment-based language or language that exaggerates or misleads
The days of thoughtlessly marketing your ICO with spammy marketing tactics are over. It’s critical to be as honest and transparent as possible, and ensure that no language misrepresents what you are offering to your community. It can be tempting to exaggerate or sensationalize your ICO launch or the future investment gains of your project, but marketing a token as a speculative investment can increase the likelihood that your token is a security.
Don’t overestimate any claims relating to your technology, advisors, and team or anything else. Instead of promoting your token as an investment that will increase in value and deliver returns, promote the token based on its functionality and the use case for the network.
Always keep in mind that while your marketing efforts are looking to raise funds and promote your token, the primary focus of your external communications should be your project’s vision, product, and development.
Keep external communications restricted
The downside of this is that you will be reducing your project’s exposure as not all team members will be able to promote the ICO through their networks and at events etc. If you don’t want to restrict access, then make sure every team member is well versed in the legal aspects of ICO marketing. You should also encourage your team to consult with decision makers before any communications are released. This may require developing a system that enables all materials to be revised by decision makers and professional counsels before publication.
Consult with Regulators
No, that doesn’t only mean regulators in your local jurisdiction. You must understand which countries you will be doing active marketing or soliciting in as well. These are the countries for which you should get a legal review/opinion about whether your token is deemed a security and what type of laws there are surrounding the marketing of securities and non-security based offerings as well. How do different regulators define marketing? Is that physically being present? Creating a Facebook ad? The rules concerning marketing and solicitation can differ from country to country.
Physical ‘in person’ marketing
In general, if you were to attend a roadshow or present at a conference and you talk about your ICO, that would probably be deemed as solicitation. Generally, if your tokens are not securities this is not a problem, but the point is that you need to make sure by checking with a lawyer in that specific country as to whether your token is considered a security.
Social media marketing
For instance, a Facebook page for a token sale that targets people from specific countries. Targeted social media campaigns can be risky if you don’t understand the marketing and solicitation laws, especially if targeting a country where cryptos are banned or unwelcome.
Public figures/ celebrities
Connecting with influential people either in the blockchain space or your projects field is useful for credibility, reach and connections. However, projects must be very careful.
Celebrities that use their social media accounts or any other platforms to promote ICO offerings that are securities are illegal in many jurisdictions without the proper clarifications. In the US, for example, any celebrity or individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion.
Projects often try to avoid registering their offering as a security because it can be costly, time-consuming and restrictive. However, given the regulatory uncertainty that exists, some projects like Filecoin have chosen to register as a security using a structure called Simple Agreement for Future Tokens (SAFT), and market within the bounds of securities laws. This can be a valid option for projects to achieve a relative amount of regulatory certainty in an otherwise uncertain environment.
Yes, it can be cumbersome to register your offering, but, think about how expensive it could be if you decide not to register your token as a security? If laws change, your project could be in a lot of legal trouble and it may have to shut down.
Another thing to keep in mind is that a lack of legislation doesn’t mean an ICO is exempt from the law. It is quite the opposite. Teams that decide to run an ICO should be extra careful and determined to be compliant to avoid inadvertently committing any offenses.
Whether you choose to register your token as a security or not, there are several legal pitfalls to navigate when marketing your ICO that need to be considered. Proceed with caution.
If you’re planning an ICO, consult with a good lawyer and a knowledgeable consultant to mitigate the legal risks associated with ICO marketing. Token Deck is an Initial Coin Offering solution that makes the ICO process safe, compliant and easy.
For more information about the many considerations involved in the ICO process, you may also want to get your eyeballs on these two posts on how to secure your ICO from hackers and ICO cybersecurity best practices.
Our comprehensive How to Launch an ICO guide will also be assistance.
Anthony is the head of content and research at Intrepid Ventures. He has spent the past several years researching and analyzing technologies and working with a diverse mix of blockchain companies to help them gain insight and develop authoritative content.
Disclaimer This document does not constitute legal or investment advice nor should be taken as such. You should not rely on it and if seeking to do an ICO or any other related activity you should seek separate professional counsel. It is for informational purposes only. Views do not represent the views of my employer, investors, or partners. Furthermore, the blockchain industry and technology is undergoing constant development so this post is intended as a guide at the current moment of publication and the issues and topics, and therefore the guidance, covered are vulnerable to change and development. The reader should bear this in mind when reading.
Also published on Medium.