Bridging the Week by Gary DeWaal: August 5 - 9, and August 12, 2019 (Securities or Not; Swap Dealer Misleading Information; Market Abuse)

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Published Date: August 11, 2019

Last week a Canada-based social media company answered charges filed against it by the Securities and Exchange Commission in June 2019 that alleged its 2017 initial sale of digital tokens constituted an unlawful securities offering under US securities laws. The company argued that its digital tokens were not securities but were more akin to virtual currency like bitcoin. In any case, said the company, the SEC never provided it with adequate notice regarding what cryptoassets it might consider to be securities. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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In its complaint, the SEC alleged that, from May through September 2017, Kik conducted an initial coin offering of one trillion Kin digital tokens without registering the cryptoassets with the SEC as required by law. According to the SEC, investors who purchased Kin tokens made an investment of money in a common enterprise with Kik and with other investors, and reasonably expected profits through the business and management activities of the company and its agents. The SEC alleged that, through its Kin offering, Kik raised almost US $100 million, including more than US $55 million from US investors. (Click here for background regarding the SEC’s complaint in the article “SEC Kicks Canada-Based ICO Issuer; Claims It Conducted Unregistered Securities Offering to US Persons” in the June 9, 2019 edition of Bridging the Week.)

In its answer, Kik said its Kin token was not an investment contract, but instead was a non-security digital token of the nature of a “community currency” more akin to bitcoin. Kik claimed that the SEC based its allegations on quotes taken out of context, and documents and testimony provided to the SEC that the SEC also misrepresented. Additionally, Kik claimed that the SEC wrongly conflated its pre-token distribution event (“TDE”) token sale to accredited investors in the United States and its subsequentTDE to retail and non-retail persons as a single unlawful event. (“TDE” is the term used by Kik to describe its initial coin offering.)

Kik’s answer provided extensive, specific examples purportedly supporting its claim that the SEC selectively used or misrepresented quotes, documents and testimony, as well as numerous legal arguments as to why Kin tokens were not investment contracts. Principally, Kik argued that it consistently noted that Kin’s success would “involve the efforts of users and content providers other than Kik,” and the price of Kin would depend on ordinary forces of supply and demand and not from Kik’s efforts.

Additionally, Kik posited that even if the SEC now believes that Kin tokens are investment contracts (and thus securities), a prosecution based on such a view violates its due process. This is because, prior to the TDE, the SEC never provided sufficient guidance for Kik to understand that the sale of Kin in its TDE would violate relevant law. 

Kik also claimed the its TDE pre-sale to US accredited investors was authorized by applicable SEC rule (click here to access background regarding Reg D) and was a distinct event from the TDE. As a result, it submitted it should receive judgment in its favor at least as to that portion of the SEC’s complaint.

My View: Both the SEC and Kik have diametrically different views regarding the circumstances that led to the issuance of Kin, both during its pre-TDE fund raise and during its TDE. In its answer, Kik requested that triable facts be heard by a jury, and it may likely be that a jury determines the ultimate outcome of the SEC’s enforcement action if it is not resolved earlier through motion practice or settlement. 

However, Kik makes a compelling argument regarding the lack of concrete guidance from the SEC regarding its view of the types of cryptoassets whose offer or sale could lead to an SEC enforcement action for violating registration requirements. Kik argues that its prosecution by the SEC without concrete advance guidance deprives it of due process. This is an argument that will likely be addressed further through motion practice.

Although the SEC has issued frequent, thoughtful guidance regarding the qualities of cryptoassets that might implicate securities registration requirements, the guidance has generally been high-level, and solely offered broad considerations as opposed to detailing how such considerations might be applied to specific fact patterns.

For example, during the same week in June 2018 that William Hinman, SEC Director of Corporation Finance, provided useful insight into how the virtual currency ether may once have been a security but is no longer, as well as general views on when sales of a cryptoasset might implicate US securities laws, the Canadian Securities Administrators issued similar guidance but included 14 specific fact patterns derived from actual episodes it has considered, and provided its conclusions as to whether the referenced digital token had characteristics of a security or not. (Click here for details in the article “Anything but Sleep Inducing: SEC Corporation Finance Director Says Ether Not a Security and Canada Issues Guidance on Utility Tokens” in the June 17, 2018 edition of Bridging the Week.)

Similarly, in April 2019, SEC’s Strategic Hub for Innovation and Financial Technology issued guidance on what characteristics a cryptoasset might possess that could make it more likely to be deemed an investment contract, and thus a security, under US securities laws. This guidance included 38 factors to consider. According to SEC Commissioner Hester Peirce, this “Jackson Pollock approach to splashing lots of factors on the canvas without any clear message leaves something to be desired.” (Click here to access background on the FinHub guidance in the article “SEC Staff Outlines Characteristics of Cryptoassets That Could Cause Them to Be Regarded as Securities” in the April 7, 2019 edition of Bridging the Week. Click here for more on Ms. Peirce’s observations in the article “SEC Crypto Guidance Employing Jackson Pollock Techniques Too Cryptic Says Commissioner Hester Peirce” in the May 12, 2019 edition of Bridging the Week.) 

Contrast FinHub’s approach with that of the Financial Conduct Authority two weeks ago when the UK regulator issued its own guidance regarding how different types of cryptoassets likely fall within its regulatory perimeter. Rather than just being high-level, in many cases, the FCA provided alternative examples of characteristics of a cryptoasset that are critical to such a determination in the form of “case studies” and provided a clear statement of the FCA’s legal conclusion (e.g., the referenced token was likely regulated or unregulated). (Click here for background in the article "UK Chief Financial Conduct Regulator Provides Final Guidance on Interface Between Cryptoassets and UK Regulatory Perimeter" in the August 4, 2014 edition of Bridging the Week.)

Although the SEC often cites the 1946 Supreme Court decision in SEC v. W.J. Howey to support its high-level views, it is one thing to set forth elements that should be considered, and another to provide practical guidance that practitioners can use to apply Howey to different specific fact patterns involving a relatively new financial asset that does not fit neatly within traditional product boxes and may often change determinative characteristics over time. Due process, let alone fundamental fairness, requires more specific guidance. (Click here to access a copy of the Howey decision.) 

More Briefly:

For further information

Brokerage Company Fined by LME for Failure to Maintain Adequate Risk Management Systems:,-a-,F-Man-Capital-Markets-Limited.pdf

Canada-Based Social Media Company Kicks Back at SEC for Enforcement Action Alleging Digital Token Sale Constituted Unlawful US Securities Offering:

FINRA Reminds Members It Is in Their Best Interest to Prepare for Compliance With New SEC Regulation Best Interest by June 202o:

Forex Dealing Member Sanctioned by NFA for Failing Timely to Adjust Customers Hurt by Ongoing Trading Platform Malfunction:

ICE Futures U.S. Proposes No Delay in Hedging Trades Related to Pre-Execution Negotiated Options Cross Trades:

Swap Dealer Sanctioned $2.5 Million by NFA for Providing Customer Misleading Information Regarding Forward Contracts Pricing:

Two Traders Charged With Disruptive Trading and Failure to Cooperate by CME Group Exchanges:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of August 10, 2019. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or employees.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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