SEC Says Digital Assets May not Be Securities in the Future

On August 9, 2022, the U.S. Securities and Exchange Commission (“SEC”) issued a Cease and Desist Order against Bloom Protocol, LLC (“Bloom”) and agreed to a related Offer of Settlement in respect of Bloom’s unregistered initial coin offering (“ICO”). While the SEC entered into many similar settlements with ICO issuers late in the tenure of former Chair Jay Clayton, this appears to be the first such settlement under the stewardship of current Chair Gary Gensler with an ICO issuer where there were no allegations of misconduct other than conducting an unregistered offering of securities.

The alleged facts of the Bloom ICO are similar to those of many other SEC settlements with ICO issuers such as Airfox, Paragon Coin, and Enigma. Bloom offered and sold its tokens to the public, raising nearly $31 million from the sale of tokens to over 7,000 investors. While the tokens were sold by a non-US subsidiary of Bloom, the SEC alleged that the funds were actually controlled by the US entity. Tokens were then allegedly sold to a number of US investors in a “pre-sale” that appears to have been conducted under Rule 506(c) – private placements using general advertising or general solicitation to all verified accredited investors – followed almost immediately by a public sale that included US purchasers and made no attempt to verify accredited investor status. The release then goes to great lengths to establish that the tokens were securities under the Howey test, particularly focusing on investors’ expectations of profits. The other prongs of that test – an investment of money, into a common enterprise, and efforts of others – are largely assumed.  

The terms of the settlement also largely match the terms of prior settlements. Bloom is to issue a press release notifying the public of the order, permit investors to make claims, file a Form 10 registration statement under the Securities Exchange Act of 1934 to register the “BLT” tokens, and then offer rescission of the token once the registration statement is effective. 

In addition, Bloom was charged a civil penalty of a little more than the total amount it raised in the pre-sale and public sale.

The Order contains an interesting new paragraph, not present in any of the prior ICO settlements, that could hint to the SEC’s view on making future determinations of whether a digital asset is a security:

“If Respondent plans to file a Form 15 to terminate its registration pursuant to Rule 12g-4 under the Securities Exchange Act of 1934 on the grounds that the BLT no longer constitutes a “class of securities” under Rule 12g-4 because the BLT is no longer a “security” under Section 3(a)(10) of the 1934 Act, Respondent will notify the Commission staff at least thirty (30) days prior to such filing. Upon such notification, the Commission staff may make reasonable requests for further information, and Respondent agrees to provide such information, as applicable.”

This appears to be an admission by the SEC of a belief held by many practitioners in the digital asset industry – that a token that was once a security could, under the right circumstances, cease to be a security at some point in the future. It is unclear from the Order what basis the SEC might assent to a digital asset’s treatment as a non-security. While in the past, the SEC released guidance on when a digital asset might be an investment contract under Howey with a heavy focus on operationality and decentralization of the underlying protocol, the Division of Enforcement has tried to walk this back in its prosecution of the XRP case against Ripple. This language could hint that the SEC may at some point become willing to make determinations that digital assets are not securities beyond the extremely limited three examples where the SEC has granted no-action relief in Turnkey Jet, Pocketful of Quarters, and VCOIN.  

Similarly, it appears that there may be a glut of forthcoming enforcement actions against issuers of ICOs that happened shortly after the publication of the “DAO Report,” particularly as applicable statutes of limitations come close to expiring. For example, on August 16, the SEC filed a complaint against Dragonchain with similar allegations. Additional lawsuits are likely to be filed in the near future.