97 N.C. L. Rev. 220 (2018)
Initial coin offerings (“ICOs”) are one of the hottest topics in corporate finance. An ICO is a form of crowdfunding where start-ups or online projects raise money by creating and selling their own virtual tokens. Seemingly free from the burdens of registration under the Securities Act of 1933 (“Securities Act” or “Act”), ICOs attracted almost $4 billion in investments in 2017, exceeding the total value of venture capital investments in blockchain projects.
The Securities Act requires that, absent an exemption, all offerings and sales of securities be registered with the Securities and Exchange Commission (“SEC”). Registration requires certain disclosure documents. These include a prospectus—which details the company’s business, management, and financial performance—and periodic reports filed with the SEC that disclose the company’s operating performance to investors. Securities issuers incur substantial costs to comply with SEC registration and periodic reporting requirements. In an initial public offering, issuers incur, on average, underwriter fees of between 4% and 7% of the gross proceeds, plus an additional $4.2 million in legal, accounting, and other costs directly attributable to the offering. Additionally, the average public company incurs costs of at least $1 million annually to comply with SEC regulations.
Many promising early-stage start-ups seek financing from venture capital funds or other private investors. Typically, to obtain venture capital financing, start-up founders must sell some of their equity in the growing business. The regulatory burden is lower than conducting a public offering, but founders often must cede some degree of control over the management of the business, as well as a portion of their interests in their businesses’ profits.
Prior to December 2017, many viewed ICOs as falling outside the reach of federal securities laws and SEC jurisdiction despite indications that the SEC intended to regulate these offerings.
Because of this, ICOs appeared to be a source of financing that avoided the burdens associated with a registered offering and lacked the downsides of obtaining private financing. Entrepreneurs who chose to conduct ICOs believed that cryptocurrency offered a way to finance growth (while avoiding SEC oversight and regulations) and maintain full control over operations and profits of the growing business.
In December 2017, the SEC instituted cease and desist proceedings against Munchee Inc. in Munchee Inc. (proceedings referenced throughout as “Munchee”), finding that its ICO was an unregistered securities offering in violation of section 5 of the Securities Act. This Recent Development argues that the SEC’s reasoning in Munchee is far-reaching and that its enforcement action represents a turning point for the cryptocurrency industry, calling into question the continued usefulness of ICOs as a form of financing.