I nitial coin offerings (ICOs) are a hot topic among federal legislators, regulators, financial market professionals, and even athletes and celebrities. An ICO is a method of raising capital in exchange for digital "coins" or "tokens" that entitle their holders to certain rights. The popularity of ICOs has surged over the past 18 months. China and South Korea have banned ICOs altogether, and policymakers in a number of other countries have warned that certain unregistered ICOs may run afoul of their securities laws. Other countries have developed proposed rules or legislation specifically directed at regulating ICOs, while still others have released guidance clarifying the application of existing laws to ICOs. U.S. securities regulators have also actively monitored the rise of ICOs. The Securities and Exchange Commission (SEC) has cautioned that depending on their features, ICOs may qualify as offerings of "securities" subject to federal regulation under the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act). The Chairman of the SEC has indicated that the agency's Division of Enforcement will "vigorously" police ICOs for violations of the Acts' registration and anti-fraud provisions. Consistent with this representation, the SEC has brought a number of enforcement actions related to unregistered and fraudulent ICOs, and has reportedly issued a number of subpoenas to other token issuers. While the SEC's enforcement efforts do not present a complete picture of the agency's views on when ICOs will qualify as offerings of "securities," they provide insight into the agency's general approach to these transactions. This report discusses the principles that the SEC and courts use to determine whether a transaction qualifies as an offering of "securities" under the Securities Act and the Exchange Act, and the application of those principles to ICOs. Second, the report reviews a popular method for structuring ICOs—the Simple Agreement for Future Tokens (SAFT)—that has been developed with the goal of allowing the tokens issued pursuant to certain ICOs to trade free from SEC oversight. The Securities Act and the Exchange Act

Whether an ICO involves an offering of "securities" has important legal implications. In SEC v. W.J. Howey Co . , the Court explained that a transaction is an "investment contract" when it involves (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profit, (4) to be derived solely from the efforts of others. Accordingly, in applying the test, the Court has emphasized the importance of the "economic realities underlying a transaction," as opposed to a transaction's form or the name that its promoters give it. Because the coins or tokens issued pursuant to ICOs are incredibly diverse, and the Howey test's application depends upon highly fact-intensive evaluations of a transaction's specific features, it is impossible to draw broad conclusions concerning the application of the Howey test to all ICOs. Specifically, the SAFT's developers argue that tokens issued pursuant to SAFTs may not involve the required "expectation of profit" derived from the "efforts of others" because (1) token purchasers are motivated primarily by a desire to use or consume products or services, and (2) the relevant "efforts" to make the tokens useful occur before the tokens are delivered to investors. However, courts and the SEC have not evaluated whether the SAFT framework in fact achieves its intended goal of avoiding regulation under the securities laws. The DAO Report

In July 2017, the SEC issued a report of investigation concerning an unregistered sale of digital tokens by an unincorporated entity organization called "The DAO." Munchee

In December 2017, the SEC instituted cease-and-desist proceedings against Munchee, Inc., the creator of an iPhone application involving restaurant reviews. Possible Exemptions from Registration

In light of the various uncertainties with the application of the Howey test to ICOs and the limited guidance offered by the SEC to date, commentators have discussed whether, assuming ICOs qualify as offerings of "securities," certain exemptions from the Securities Act's registration requirements may be available to token issuers. However, commentators have raised concerns about such offerings. Regulation A provides exemptions for two "tiers" of offerings. The subsections below review a number of these proposals. The SEC is responsible for regulating virtual currencies that qualify as "securities."
Initial coin offerings (ICOs)—a method of raising capital in exchange for digital coins or tokens that entitle their holders to certain rights—are a hot topic among legislators, regulators, and financial market professionals. In response to a surge in the popularity of ICOs over the past 18 months, regulators in a number of countries have banned ICOs. Other foreign regulators have cautioned that unregistered ICOs may violate their securities laws, issued guidance clarifying the application of their securities laws to ICOs, or proposed new rules or legislation directed at regulating ICOs. ICOs have also attracted the attention of U.S. securities regulators. The Securities and Exchange Commission (SEC) has cautioned that depending on their specific features, ICOs may qualify as offerings of "securities" subject to federal regulation.
Whether an ICO involves an offering of "securities" has important legal consequences. Section 5 of the Securities Act of 1933 (Securities Act) requires issuers of securities to register their offerings with the SEC or conduct them pursuant to a specific exemption from registration. Issuers and sellers of securities also face anti-fraud liability under the Securities Act and the Securities Exchange Act of 1934 (Exchange Act). The SEC has the authority to investigate and punish violations of the securities laws, and has indicated that it will "vigorously" police the burgeoning ICO market for such violations.
To determine whether a transaction involves an offering of "securities," courts employ a four-part test outlined by the Supreme Court's 1946 decision in SEC v. W.J. Howey Co. Under that test, a transaction qualifies as an offering of "securities" if it involves (1) an investment of money, (2) in a common enterprise, (3) with a reasonable expectation of profit, (4) to be derived from the efforts of others. In applying the Howey test, the Court has emphasized the importance of analyzing "the economic realities" of a transaction, as opposed to its form or the label that its promoters give it.
Because ICOs are incredibly diverse, it is impossible to draw broad conclusions about their status under the securities laws, which will depend on fact-intensive inquiries into details that vary among different ICOs. As a general matter, though, ICOs are more likely to qualify as offerings of "securities" when token purchasers (1) are motivated primarily by a desire for financial returns (as opposed to a desire to use or consume some good or service for which tokens can be exchanged), and (2) lack a meaningful ability to control the activities on which their profits will depend. In light of these principles, attorneys have developed a method for structuring ICOs—the Simple Agreement for Future Tokens (SAFT)—that attempts to avoid classification of the tokens issued pursuant to certain ICOs as "securities." However, whether the SAFT achieves its intended goal remains subject to significant debate.
The SEC has pursued a number of enforcement actions related to unregistered ICOs. In July 2017, the SEC issued a report of investigation concluding that tokens issued by an unincorporated organization called "The DAO" qualified as "securities" under the Howey test. And in December 2017, the agency reached the same conclusion about tokens issued by Munchee, Inc., the creator of an iPhone application involving restaurant reviews. These enforcement actions, and a prominent speech given by an agency official in June 2018, offer some guidance on the SEC's views on when ICOs will qualify as offerings of "securities."
The Securities Act and related regulations offer a number of exemptions from the Act's registration requirements for offerings that meet certain conditions. However, some commentators have doubted the attractiveness of the relevant exemptions for ICOs. Commentators have also proposed a number of policies to improve the regulation of ICOs, ranging from a specific registration exemption for ICOs to a "safe harbor" for certain token exchanges.