Token sellers beware: it’s a legal minefield out there

Token sales have raised over US$3 billion this year, and regulators around the world are getting concerned – but their different approaches are causing confusion, say analysts

PUBLISHED : Monday, 11 December, 2017, 9:15am
UPDATED : Monday, 11 December, 2017, 9:15am

Different regulators around the world have adopted varying attitudes when it comes to initial coin offerings (ICO), also called token sales. However, because they take place online, token sales can, and normally do attract investors from all over the world.

And that can cause problems for those carrying out such sales, say analysts, because even if token sellers are compliant with regulations in one market, they can still fall foul of rules in another.

An ICO is a means by which companies developing projects using digital tokens can raise capital. Each project will use its tokens in a different way but, as with traditional money, they may be used as a store of value, a medium of exchange, a unit of account, or some combination of them all.

Regulators can take action against a company marketing an ICO to potential investors in their jurisdiction, even if the company itself is based somewhere else
Adrian Lawrence, Baker McKenzie

Investors purchase tokens before the launch of the project, hoping it will be successful and the tokens will acquire real value so they can be traded on the many cryptocurrency exchanges springing up all over the globe.

Token sales have raised more than US$3 billion so far this year, and regulators around the world are starting to get concerned.

The watchdogs tend to fall into two camps when it comes to ICOs. Many, like those in Australia, Hong Kong and Singapore, for example, say that if a token has the characteristics of a security, an ICO should be governed by existing securities laws, and not if it doesn’t.

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Some others, like China and South Korea, have taken steps to stamp them out altogether.

Most companies executing an ICO claim to be issuing a so-called utility token and not a security.

“The problem for companies carrying out an ICO is that different laws may have slightly different rules as to what a security is,” said Adrian Lawrence, Asia Pacific chair of law firm Baker McKenzie’s technology, media and communications group.

“Also, regulators can take action against a company marketing an ICO to potential investors in their jurisdiction, even if the company itself is based somewhere else.”

All of this is particularly important for Hong Kong as, according to Karen Contet Farzam, a member of the board of the FinTech Association of Hong Kong, the city is one of the leading jurisdictions for companies looking to launch an ICO. Indeed, last week the association published a paper on the subject.

“The fintech community in Hong Kong is keen to ensure that those who decide to conduct a token sale do so by implementing the latest global best practices in this space. Whilst there are no detailed regulatory guidelines around token sales, we believe it is important for the community to set some voluntary best practices that entrepreneurs can follow,” Farzam said.

Legal considerations are an important part of this, particularly when these issues cross borders.

As ICOs are illegal in mainland China, companies need to be able to demonstrate that they have taken steps not to sell to investors on the mainland.

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“In practical terms, if a company has taken reasonable steps to stop purchasers from jurisdictions where their ICO is not compliant from buying tokens, regulators in those jurisdictions may be a bit more flexible as compared with the case where an ICO has significant numbers of purchasers from that country,” said Lawrence.

“Nor do companies carrying out an ICO just need to consider financial services legislation,” said

Urszula McCormack, a partner at law firm King & Wood Mallesons, and co-chair of the FinTech Association’s policy and advocacy committee.

On December 4, the US Securities and Exchange Commission announced it had obtained an emergency asset-freeze to halt an ICO fraud that had raised as much as US$15 million from thousands of investors since August by falsely promising a 13-fold profit in less than a month.