It may have seemed like a good idea to send aWells Noticeto KIK[1].
KIK sold millions of dollars worth of KIN tokens to U.S. persons in an ICO; an unregistered sale of consumptive tokens[2]. Under the SEC guidance to date, that is an illegal sale of securities, punishable under the Securities Act of 1933. So far (other than KIK), every token issuer to whom the SEC has focused its attention has bowed down without much of a fight.
As the SEC was to find out, KIK would not follow that pattern.
In fact, KIK would fire back, responding to the SEC in apublic letterwritten by one of the most expensive law firms on the face of the earth, Kirkland & Ellis. Now the SEC has a Hobsons choice. Pursue KIK in an action where even if they win, they really lose; or slowly and quietly back away with no further action.. continuing their unfortunate silence as to regulatory guidelines for sales of digital assets.
KIKs sale of KIN tokens took steps to avoid classification as a regulated sale of securities:
- KIKs messaging app existed prior to the issuance of KIN tokens.
- KIK payed income tax on the proceeds they received from sale of KIN tokens.
- KIK put a cap on the amount of Tokens any single purchaser could purchase of $4,400.
- KIKs offering materials did not tout the KIN token as an investment.
Whether the sale of the KIN tokens was a public sale of securities, conducted illegally, can be hotly debated[3]. More importantly, a decision either way would provide some needed regulatory guidance with respect to the laws applicable to sales of digital assets. Accordingly, many, including Ted Livingston, the CEO of KIK, would very much like to see this case move forward.
As if the stakes were not high enough, the SEC has another problem; even if they win, they lose. One of the main reasons the SEC exists is to protect the Main Street investor. Unfortunately, as astutely pointed out in KIKs response to the Wells Notice, enforcement against KIK will hurt the very people the SEC is supposed to protect. The KIN ICO raised nearly $100 million from a large number of people. Given the $4,400 per person cap on purchases, over 20,000 people purchased KIN. In the two years that followed many of those original purchasers sold the KIN they purchased to secondary purchasers.
At this point, the KIN token is very widely distributed. If the SEC were to succeed in an enforcement action against KIK, the main result would be that KIK would be subject to large scale monetary penalties[4]. Even bringing the enforcement action will result in an expensive battle for KIK[5]. That liability results in a major detriment to KIKs ability to further their project, ironically the very thing that the current holders of KIN need to succeed in order to see the value of their KIN tokens increase[6]. In short, if the SEC wins, the Main Street investors holding KIN lose.
The SEC already has a perception problem. No one denies that protecting the Main Street investor and overseeing orderly markets is a very worthwhile goal. The problem is that in pursuing that goal, the SEC has created a perception that they are against innovation. They may protest otherwise (and they may be right), but as issuers of digital assets eschew the United States for more lenient (or at least more definite) regulatory environments, one cannot deny that the SEC appears at best reticent to allow the new technology to flourish. One can imagine the outcry from the public that would result if the SEC pursued KIK for a win with a draconian penalty.
So now what? Nothing actually compels the SEC to pursue KIK any further. The purpose of the Wells Notice, is, in fact, to allow a would be target of SEC enforcement an opportunity to convince the SEC not to take action. If the SEC brings the case, they have no truly positive outcomes. If the SEC announces they will not bring the case, they embolden issuers of digital assets to encroach on turf the SEC has thus far vigorously defended. Of course, the SEC can stick with its establishedmodus operandi, provide no guidance at all. Say nothing at all; just back away, slowly. Unfortunate, but probable.
What does it allmean?
We have echoes of the development of peer-to-peer music sharing. That new technology also disrupted the established methods. At the height of folly, the RIAA[7]brought over two hundred actions against otherwise law-abiding individuals, in many cases seeking tens of thousands of Dollars as punitive damages for very limited copyright violations. Although on the facts most of those cases did involve violations, pursuit of those actions was obviously on the edge of ridiculous. We now have new business models in respect of music distribution.
Much like the actions of the RIAA, the SECs unfortunate activities in respect of KIK illustrate what should be an obvious conclusion (though maybe an inconvenient truth). Digital Assets are a new class of assets. Sometimes, they will be similar to securities, commodities and/or currency, and could be regulated as such. There are however, different models, which require new thinking in terms of regulation. As much as the SEC protests otherwise, the world has a new asset class (maybe more than one), and new rules are required.
[1]KIK is a Canadian company that developed a messaging application that included in its functionality use of the KIN token as a medium of exchange.
[2]The KIN Token serves as a medium of exchange or currency within KIKs messaging app ecosystem. One aspect of the medium of exchange business model is that unless there is an outside source of liquidity for the token, it is really just the same as a loyalty point (frequent flyer miles, etc.).
[3]The Author has a definite view, however, that view is not relevant to the SECs dilemma.
[4]One of the main remedies for an illegal unregistered offering of securities is rescission, however, with so many secondary sales, refunding funds to the initial purchasers is likely impractical. As an alternative, a court may order other large scale remedies.
[5]Ted Livingston, the CEO of KIK, states that KIK has already spent more than $5 million as a result of SEC activities.
[6]Value increase for consumptive/currency tokens is based on a finite or limited amount of tokens being required for a growing demand of the applications relating to those tokens. By cutting off a companys ability to create that demand, the SEC would also cut off the potential appreciation in value of the KIK token.
[7]Recording Industry Association of America.
Josh Lawler, a partner atZuber Lawler,is an experienced attorney with concentrations in M&A, finance, intellectual property, and general commercial transactions.
Josh Lawler is is a partner at Zuber Lawler whose practice focuses on mergers & acquisitions, securities law and technology transactions.
