In the tech industry, it is common for startups to ask for forgiveness and not permission from regulators. The basic idea is to gain user traction or launch a product quickly before building a case for it with regulators. The latest batch of SEC settlements with crypto startups illustrates the effectiveness of this strategy.
In two separate releases earlier this week, the federal agency stated that it had settled with two startups for offerings of tokens that it deemed as securities. But the settlements turned out to be more of a win for the companies than the agency.
Block.one, which conducted the world’s biggest ICO in 2018, paid a measly $24 million fine (or approximately 0.6 percent of the total funds received) for an ICO that raked in more than $4 billion. The startup also obtained a waiver from the SEC for future Reg. A and Reg. D offerings, two types of fundraises that do not have the stringent requirements of public offerings, because it has agreed to cooperate with the agency. In other words, Block.one can conduct raise further capital from private markets in the future without pushback from the agency.
The second settlement was with Nebulous, the Boston-based startup behind Sia – a decentralized storage platform. For a 2014 offering that raised $120,000, the startup paid a penalty of approximately $250,000. The fine amount is peanuts as compared to the $1.5 million it raised through a regulated token security offering in 2018. The company has also submitted a request for a future fundraise waiver similar to the one granted to Block.one.
An Exception to the Rule?
The SEC hasn’t always been this accommodating or lenient for other offerings. In previous cases, it has asked issuers to return money to harmed investors, register the offering as one for securities, and file periodic reports with it.
Per the releases, neither Block.one nor Nebulous has to comply with these requirements. This, despite the fact that both did not have a working product or a test environment in place when they made the offering.
So, what tilted the balance in their favor?
Most observers say this is probably because the startups agreed to cooperate with the agency, instead of fighting it.
But that may only be part of the story.
Block.one and Nebulous are well-funded startups and employed an expensive legal team (from the same firm) to make their case with the SEC. It is likely that the SEC’s judgement would have been much harsher, if the lawyers were different. Block.one also developed applications, such as the Voice social media platform on the EOS blockchain, to show proof that it had invested raised funds into development work.
Meanwhile, there has been a flurry of commentary and tweets regarding the settlements. With each SEC enforcement action, the crypto ecosystem reads the tea leaves for regulatory clarity regarding crypto tokens.
But the two settlements today are unique. The SEC Chairman Jay Clayton has repeatedly clarified that the Howey Test is sufficient to determine the status of a token. Today’s settlements, lenient as they might seem, do not change that stance.
That said, the Block.one settlement is unique in one sense. In its waiver letter, the startup referenced the venture capital fund it started to invest in funds and applications developed on its blockchain, EOS. As it turns out, those funds might be constrained from making Reg. D offerings of their own in the United States due to their association with EOS. The waiver, however, makes sure that Block.one’s venture fund is free to make investments into other funds and multiply its capital.
Typically, blockchains establish nonprofit foundations to fund development work and market their platforms. Once the blockchain reaches maturity, as it has in the case of Ethereum, the foundation shifts focus. Block.one’s move to establish a venture fund is a novel one in this context and might set a blueprint for other blockchains.