The United States Securities and Exchange Commission (SEC) is in charge of regulating financial markets in the U.S., and they have jurisdiction over new ICOs when their investment products are sold to American consumers. While it’s possible to create an ICO that’s legal in the United States, the SEC follows a set of rules known as the Howey Test to determine if the ICO is tradable security or not. ICOs that fail the Howey Test is subject to all the same regulations as public stocks, and they must be registered and follow strict securities law.
The
financial and logistic burdens of creating compliant, publicly traded security
are high for most companies, let alone startups on the blockchain. Therefore,
if you want to launch an ICO that’s available to American consumers, it has to
pass the Howey Test. Regulations in the European Union also closely mirror the
Howey Test’s guidelines. This article is not legal advice and shouldn’t replace
hiring a lawyer if you’re launching an ICO. However, it will give you
guidelines and best practices from other crowdsales on how to create a
compliant ICO.
Regulations Around Investment
Vehicles and Securities
With the
recent boom in Ethereum-based ICOs, regulators have begun to turn their
attention toward cryptocurrencies. Securities commissions exist to protect
consumers from dangerous or fraudulent investments, and the recent increase in
ICOs has also meant an increase in pump and dump schemes where the tokens have
no inherent value. Regulators are understandably concerned about fraudulent ICO
activity. In many cases, it’s difficult to perform an audit of an ICO or to
evaluate a token’s legitimacy.
What is the Howey Test and How Does It Work for ICOs?
The Howey
Test comes from a 1946 United States Supreme Court case known as SEC vs. Howey
Co., in which the Supreme Court created a simple test for determining if a
transaction is considered an “investment contract” and is therefore subject to
securities law and regulations. Over seven decades later, this test is still
the standard by which new financial instruments are judged in the United
States, including today’s ICOs.
Another Option: Exclude U.S.
Investors
Rather than
deal with the uncertainty of whether an ICO passes the Howey Test, many new
companies choose to forego U.S. investment altogether. Nearly every major token
sale in the past six months has excluded U.S. investors. If U.S. citizens want
to purchase a token, they have to wait until it is listed on public exchanges.
The keys to
creating a compliant ICO that follows the Howey Test are simple. First, make
sure that token purchasers do not expect to profit, and say so publicly before
the launch starts. Second, make it clear that your token has a specific purpose
and utility. Buyers should know what they’re getting in return for their
purchase. Alternatively, you can forego the SEC entirely by excluding U.S.
investors from your token sale.
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