‘This Is Not an ICO, Just Barter’ – How Issuers Attempt to Evade Regulatory Scrutiny

2019-4-3 13:20

Some issuers of initial coin offerings have started to change the terminology they use to refer to their token sale in a bid to evade the attention of regulators – the hawkish U.S. Securities and Exchange Commission (SEC) in particular. With research finding that fewer than half of ICO projects make it past the first few months of their token sale, regulators have become increasingly concerned about ICOs, many of which have turned out to be elaborate scams.

Also read: Why Africa Continues to Lag Behind in Cryptocurrency Adoption

Bartering an ICO

In 2017, Tokenpay fancied itself as an initial coin offering, targeting to raise $41 million by selling a part of the total 25 million of its Tpay tokens to the public. Today, the company, which was attempting to build a ”secure blockchain payments platform,” denies having floated an ICO at all, to the point of claiming its token was valueless.

“We never conducted an ICO,” Tokenpay stated in a fire-fighting tweet, to an unconvinced audience. “We bartered our unique blockchain coins called $Tpay for one called $BTC,” it retorted, adding: “Nowhere will you find any suggestion of an implied investment or offering of any sort. In fact, every single page on the whitepaper and website states that the coin has no value.”

This may be the most complex definition of an initial coin offering yet. Even users of Tpay found this difficult to believe. “I didn’t walk to the park. I carried my body to the park with the willful assistance of my legs,” snorted @woolsim. Ari Paul commented: “There are probably some interesting nuances where this makes a difference, but for most regulatory purposes pretty sure it’s a “sale” if you receive something of value for something you are giving away.”

Tokenpay stood its ground, declaring its “barter” was closed to U.S. citizens, therefore the SEC couldn’t touch it. However, U.S. attorney @stephendpalley proved the company wrong, creating an account inside the U.S. within 15 seconds while “eating refried beans” at a cafe. “To be clear, we have never sold, bartered or negotiated any coins with U.S. persons. Nor do we make our products, including wallets and DEX, available to U.S. persons. We are not a U.S. company,” Tokenpay charged.

But it doesn’t really matter by what name Tokenpay calls its ICO. The real verdict lies with the Securities and Exchange Commission, which, through its Howey test, will determine the label by which the Tokenpay “barter” will be called. The test is a legal standard that determines whether certain transactions qualify as investment contracts.

Regulatory Concern

Now, regulators throughout the world have expressed concern at the legitimacy of initial coin offerings, claiming they have become a haven for fraudsters keen on making a quick buck. ICOs imitate the initial public offering of common stocks, but without the rigor of regulatory oversight, which in a sense makes them attractive to startups keen on getting around bureaucratic red tape. According to the SEC, scammers take advantage of less regulation within the ICO markets, using that ‘weakness’ to defraud and manipulate mostly unsuspecting retail investors.

For example, research by the Boston college last year found that about 56 percent of ICO projects die within 120 days of completing the sale of their tokens to the public. Most of the projects “die” with investors’ money, which is never recovered. Some estimates put the amount of total losses at a few billion dollars in 2018, the largest of these included Thailand’s Pincoin, which fleeced investors of $660 million, and India’s Onecoin, which made off with $350 million.

Against this background, the SEC, created after the 1929 stock market crash to protect investors, has sought to assert its control over initial coin offerings by tightening the regulatory environment to improve transparency. In 2017, at the peak of the cryptocurrency bull run, the regulator concluded that many ICOs should be classified as securities offerings, meaning they are now governed by the same laws that apply to stocks or bonds. It also means that such ICOs will be required to register under U.S. federal securities laws, a rigorous process that involves key financial disclosures.

Since the change, the Securities and Exchange Commission has already fined two companies, Carriereq Inc. (Airfox) and Paragon Inc., which two years ago raised $15 million and $12 million in token sales respectively, for failing to register their ICOs. The fines amounted to $250,000 against each company.

Perhaps the most interesting case is that of Maksim Zaslavskiy. The 39-year old entrepreneur pleaded guilty to a case of fraud involving securities. He operated two illegal ICOs – Recoin and Diamond Reserve Coin. Despite their promise of either offering investors access to real estate-backed investments in developed countries or access to purchase tokenized membership to a pool of wealthy investors with physical diamonds held by the company backing the token, the ICOs existed only on paper.

The two ventures scammed 1,000 investors of about $300,000, but never developed any token or blockchain-centred infrastructure. A U.S. district attorney described how those that participated in the two ICOs purchased “worthless certificates.” The Zaslavskiy case is being watched closely in the ICO industry as it carries the potential to deliver a landmark decision that would set a precedent in how fraud cases involving token sales will be handled in the future. A jury panel is expected to come up with a decision on the matter this April, but Zaslavskiy could face up to five years in prison.

Investor Protection

A major motivation behind the SEC’s increased monitoring is to “provide investors who purchase securities in ICOs with the opportunity to be reimbursed” in the event of fraud or lack of registration. The ultimate purpose though is to prevent such scams from happening at all. But issuers appear to be always a step ahead of the regulatory system, which is forced to play catch-up.

Wary of regulatory scrutiny, initial coin offerings have now metamorphosed into new forms. One of these is the security token offering (STO), a financial security loosely built on the structure of traditional shares. The STO offers investors some rights to a company and anyone intending to float one may be compelled to meet the same regulatory requirements as in an initial public offering. The requirements mostly center around issues of financial disclosure. By going the STO route, companies within the cryptocurrency industry aim to adhere to government regulations on securities while continuing to raise capital through crowdfunding.

What do you think about ICOs and regulation? Let us know in the comments section below.

Images courtesy of Shutterstock and Tokenpay.

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