SEC and Kik

This post is by Jeff Carter from Points and Figures

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I was sort of surprised by the SEC’s move to go after Kik.  But, Kik decided to poke the bear so I guess they knew it was coming.  I will leave it to the legals to figure it all out.  Kik Chief Executive Ted Livingston welcomes the chance to have a court decide whether its cryptocurrency functions like a share of stock, which the SEC alleges. “This is not about kin; this is about crypto broadly,” he said. “What’s exciting to me is that this industry is finally going to get the clarity it so desperately needs.”

He might not get the win he wants.  The SEC could act decisively and put the entire crypto sector out of business in the US with a ruling.  Or, they could act narrowly and focus just on the Kik question and make sure it doesn’t apply across board since some ICO’s look different than other ICO’s.  The one thing we do know is that the SEC will always try to protect the most inept uneducated retail investor first.  They are desperately fearful of potential fraud.  I am not saying Kik committed fraud and so far neither is the SEC.  But, through the SEC lens it might look like to the SEC that they certainly didn’t comply with traditional standards the SEC sets down.

For example, the SEC says Kik was running out of money so the ICO was a “Hail Mary”.  What about all VC backed companies that don’t earn enough money to cover their burn rates and eventually run out of money?  They traditionally raise more VC rounds.  What if Kik decided to pivot its business model and an ICO fit in with the new model?  Since it’s a true innovation away from other business models that are familiar, it fits like a square peg in a round hole when it comes to existing securities law/regulation.

However, I do think if you are operating a crypto company that did an ICO, it is best practices to follow the same SEC guidelines that any security offering would take.  It means,

  1.  Be very transparent.  This is especially true with outlining the risks.  Outline risks that aren’t even probable.  It doesn’t matter if you don’t think it’s a risk or if you think it has a snowball’s chance in hell of becoming true, outline it.
  2.  When your employees get tokens be transparent about it to token investors.  Let them know exactly the percentage that is going to the team.  If the team is forking over any cash, be very transparent about how much they are paying.  If they are being given them as return for working, show that in a broad allocation.
  3.  Have rules and filings when employees sell tokens.  There should be a lockup period just like stock.  If employees want to sell a certain percentage of tokens each month, quarter or whatever, be transparent about that and let the market see it.
  4.  Educate employees on the tax consequences of receiving tokens the same that you would stock or options.  Let them know when they will incur a tax liability.
  5.  If tokens have value subject to some event on a blockchain, be transparent about that event and what goes into it.  Treat it like earnings.
  6.  If you are an exchange, never make up volume. Washed trades are not volume.  If you are paying market makers to make markets, be transparent about the costs but not necessarily transparent about the individual payments.  If you give someone an edge by showing them the book before anyone else, tell the market.
  7.  Settle the token each and every day.  Have clear settlement procedures.  Have clear arbitration procedures.  Have clear disciplinary procedures.

One of the things that the SEC hates is uncertainty.  In Kik’s offering, there was no ecosystem developed.  The SEC can’t figure out why anyone would want to buy a token to purchase services in something that doesn’t exist.  It’s cultural.  They understand the here and now and to them it looks no different than a snake oil salesman.

You cannot just wing this.  A one-page whitepaper is not sufficient for traditional capital markets regulation.