Digital Assets As Securities Under Federal Law: The SEC's New Framework As Applied To Kik's 2017 ICO

Author:Mr Kenneth S. Witt and Mark A. Staines
Profession:Kutak Rock LLP
 
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On June 4, 2019 the SEC filed a lawsuit in federal court in the Southern District of New York against the Canadian company, Kik Interactive Inc., alleging that Kik violated the U.S. Securities Act of 1933 (the "Securities Act") in its 2017 $100 million initial coin offering ("ICO"). The SEC's complaint against Kik illustrates how the SEC may apply its recent Framework for "Investment Contract" Analysis of Digital Assets (the "Framework") for analyzing digital assets as "investment contracts" that qualify as securities subject to federal regulation.

Kik was burning through cash in 2017. Its mobile messaging app revenues were far outpaced by its costs, and Kik was unsuccessful in its efforts to find a buyer. Expecting to run out of cash by the end of 2017, Kik management decided to "pivot" to a digital asset business model and sell one trillion digital tokens in return for cash to fund company operations. The new token, called "Kin," would be developed for use in a "Kin Ecosystem" where Kin could at some future date be used to buy goods and services.

After publication in May 2017 of a "white paper" describing the planned ICO and Kin Ecosystem development, Kik implemented a sophisticated international marketing effort, including appearances on CNBC, press releases, social media activity and investor meetings akin to an initial public offering "road show."

Although warned by various parties that its activities could run afoul of the U.S. securities laws, Kik paid little heed, although it did terminate the offering in Canada after the Ontario Securities Commission raised concerns that the sale of Kin would violate securities laws because the Kin tokens were investment contracts and, thus, securities. The Canadian authorities even specifically referenced Howey, the 1946 U.S. Supreme Court case that defines an investment contract as the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.

Using the Howey test and analytical tools from the Framework, the SEC had little difficulty concluding that the Kin tokens were securities. Further, the SEC concluded that Kik was engaged in a public offering that should have been registered under Section 5 of the Securities Act, so that investors would have the protection of the prospectus disclosures required by the Securities Act.

Several factors appear to have been critical to the SEC's analysis. First, the Kik ICO was expressly marketed...

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