Wednesday, March 21, 2018

Syren Johnstone on ICO Utility Tokens and the Relevance of Securities Law (HK Lawyer)

"ICO Utility Tokens and the Relevance of Securities Law"
Syren Johnstone
Hong Kong Lawyer
March 2018, pp. 30-33
     Abraham Lincoln famously posited that if one calls a tail a leg it doesn't mean that a dog has five legs. Similarly, a blockchain-based token offered in an initial coin offering ('ICO') may, irrespective of how it is called, be a security subject to securities laws applicable to the primary market as well as secondary market activities. ICOs are an example of how new technology is changing the way the public capital market is accessed by business, typically start-ups, in need of capital.
    The legal treatment of tokens remains unclear in my jurisdictions, which is increasingly problematic as ICO activity has ballooned from around US$300 million during 2013 to 2016 to well in excess of US$5 billion in 2017. As Hong Kong is now considering its potential status as an ICO hub, it is essential that regulatory agencies and market professionals come to grips with a better understanding of how tokens are, or may be, regulated.
     A focus of this article is "utility tokens"...The nature of a utility token is to permit the holder to access a service provided by the user's platform. This is typically a pre-sale made by a start-up seeking capital to develop the promised service. ...
    The law applying to the offering of securities and their marketing in Hong Kong, as set out in the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) and the Securities and Future Ordinance ('SFO') (Cap. 571), is in general consistent with best international practices that prohibit accessing public capital unless registration or authorisation requirements are complied with it a relevant exemption applies. Tokens that are securities may also be subject to laws concerning regulated activities and the operation of exchanges and automated trading services. However, whether a specific token is a security will require careful consideration. ...
     First, because Howey has been applied to tokens by the U.S. SEC...
     Second, because of potential similarities to elements in the definition of CIS that align with, though are not identical to, the concept in Howey of a common enterprise in which the efforts of another are key.
    However, applying existing law to tokens is inherently problematic because blockchain has enabled fundamental changes in the ease and manner of accessing public capital, the cost and time of doing so, the willingness of the public to purchase tokens and the ease of trading them.
     Hong Kong practitioners will therefore need to exercise some caution when advising on the nature of a proposed token issuance and how it is undertaken.
     The increasing awareness that tokens can be subject to securities laws that possess uncertainties in their potential scope of application has had an impact on practices in the industry. ...
     While best practices have been developed to promote self-regulation of the industry, they have not always been observed in practice...
     Legal practitioners will be well aware that avoidance and evasion are quite different matters...
    While that distinction may be clear-cut in principle, the characteristics of a utility token that might cause it to be regarded as a security are less clear...
     The overarching purpose of securities laws is to regulate investments, irrespective of the form or name they assume ...
     One might point to the development of structured product regulation as a lesson in the failure of looking at how a product fits into a pre-existing set of categories, rather than considering its function in the market...
    New challenges may require regulatory agencies to interpret the law with one eye firmly fixed on regulatory intent...
   Care needs to be taken that purposive flexibility is not applied by regulators in a way that creates uncertainty...
     Returning to Abraham Lincoln, he was wrong semantically. If a tail is called a leg then it can be said that a dog has five legs. And if utility token issuances put public capital at risk, expose consumers to fraud, and behave similarly to an investment in established classes of securities, then perhaps that is enough to render it a security within the original intent of the legislature. Practitioners call it "the smell test". Indeed, the SFO provides that "interests, rights or property...commonly known as securities" are to be regarded as securities. On the other hand, calling a security a utility token does not change its nature. Click here to read the full text.

No comments:

Post a Comment

Google+ Followers