The organizers of an initial coin offering (ICO) recently won dismissal of an investor’s fraud claims by establishing that their public risk disclosures negated the investor’s claims of reliance on alleged misstatements. The project, a video service provider’s ICO, was governed by a purchase agreement called a “Simple Agreement for Future Tokens” (“SAFT”). The plaintiff investor later lost his entire investment as the token collapsed, allegedly due to the provider’s decision to scrap its initial plans for a decentralized platform and move to a permissioned blockchain (and also the provider’s choice to seek additional capital via a “Regulation A” public offering). The New York court found that even if certain representations made by the issuer regarding the prospect of a decentralized network were actionable, the Plaintiff had not plausibly alleged “reasonable reliance” on such representations in signing the SAFT. (Rostami v. Open Props, Inc., No. 22-03326 (S.D.N.Y. Jan. 9, 2023)).
In its first enforcement action of the year involving ICOs, the U.S. Securities and Exchange Commission (SEC) charged two companies and their founder for violations of antifraud and registration provisions of the federal securities laws in connection with an initial coin offering (ICO). On January 6, 2022, the SEC announced charges against Australian citizen Craig Sproule and two companies he founded, Crowd Machine, Inc. and Metavine, Inc. (collectively, the Defendants), for making materially false and misleading statements in connection with an unregistered offer and sale of digital asset securities in an ICO. (SEC v. Crowd Machine, Inc., No. 22-00076 (N.D. Cal. filed Jan. 6, 2022)).
These charges add to the SEC’s growing list of enforcement actions that target unregistered offerings of digital assets. ICO activity peaked in 2017, when hundreds of issuances raised an estimated $5 billion from investors. Since that time, scrutiny from the SEC has cooled this practice. However, the SEC remains vigilant in taking action against unregistered ICOs, based on its view that digital tokens are likely to be securities. In remarks last year, SEC Chairman Gary Gensler voiced agreement with former SEC Chairman Jay Clayton’s position on ICOs: “To the extent that digital assets like [initial coin offerings, or ICOs] are securities — and I believe every ICO I have seen is a security — we have jurisdiction, and our federal securities laws apply.”
On July 14, 2021, the Securities and Exchange Commission (“SEC”) settled an action against the operator of a platform that promoted current and upcoming digital token offerings for violations of the anti-touting provision of the Securities Act of 1933. In the Matter of Blotics Ltd. f/d/b/a Coinschedule Ltd. (July 14, 2021). The SEC claimed that the primary source of revenue for the platform operator, Coinschedule Ltd., was compensation received from issuers that paid to list, market, and rate their token offerings on the platform. The SEC charged that Coinschedule’s failure to disclose the consideration it received from token issuers for promoting their token offerings was a violation of the anti-touting provisions (Section 17(b)) of the Securities Act. The respondent, Blotics Ltd. (successor to Coinschedule Ltd.), was ordered to pay disgorgement of $43,000, plus interest, and a civil penalty of $154,434.
The settlement order does not shed any light on when a digital token is a security. The anti-touting provisions of Section 17(b) apply only if the instrument being touted is a security, and the order states that some portion of the digital tokens offered and sold on the Coinschedule platform were securities in the form of investment contracts. However the settlement order does not address how many or which of the 2,500 individual token offerings profiled on the Coinschedule platform involved securities, providing no analysis and only a conclusory statement that “[t]he digital tokens publicized by Coinschedule included those that were offered and sold as investment contracts, which are securities pursuant to Section 2(a)(1) of the Securities Act.”
Late last year, the SEC filed a litigated action in the U.S. District Court for the Southern District of New York against Ripple Labs Inc. and two of its executive officers (collectively, “Ripple”), alleging that Ripple raised over $1.3 billion in unregistered offerings of the digital asset known as XRP.…
On February 1, 2021, the U.S. Securities and Exchange Commission (SEC) announced that it had brought charges against several individuals involved in an alleged scheme to induce investors to transfer more than $11 million to buy into an unregistered initial coin offering (ICO) of B2G tokens, which the SEC claimed was merely an elaborate sham. (SEC v. Krstic, No. 21-0529 (E.D.N.Y. Filed Feb. 1, 2021)). The complaint, filed in the Eastern District of New York, alleged that Kristijan Krstic (“Krstic”), John DeMarr (“DeMarr”), and Robin Enos (“Enos”) (collectively, “Defendants”) conspired, in violation of securities laws, to defraud over 460 investors of $11.4 million with promises of large returns on investments from its offerings, including for B2G tokens that the defendants claimed were genuine digital assets for a mining and trading platform.
In October of 2019, the U.S. Internal Revenue Service issued the first new guidance on the taxation of cryptocurrency transactions in over five years (the “Guidance”). The Guidance comprising a revenue ruling (Rev. Rul. 2019-24) and answers to frequently asked questions on the taxation of cryptocurrency transactions published on the IRS’s website.
This post discusses recent news reports of statements by officials with the IRS and the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) concerning issues not explicitly addressed in the Guidance.
Please refer to our earlier post for complete coverage of the Guidance.
- Tax treatment of promotional airdrops remains uncertain
Revenue Ruling 2019-24 indicated that cryptocurrency received in a hard fork would be taxable to the owner at the moment the new units of cryptocurrency issued in connection with the hard fork are “received” by the holder of the legacy cryptocurrency, which is generally the moment the units of the new cryptocurrency are “airdropped” to the legacy holder’s wallet, provided the holder is able to exercise “dominion and control” over the units at that time.
Because the facts of the ruling involved a hard fork (i.e., a change in the protocol of a cryptocurrency’s blockchain causing the creation of a new blockchain and, therefore, a new cryptocurrency), it was not clear whether the same rule would apply to airdrops of cryptocurrency received in other contexts. Airdrops may occur for promotional or marketing purposes by blockchain-focused startups in order to generate interest in the startup in connection with an upcoming ICO or to encourage mass adoption of the cryptocurrency. The coins may be distributed for free to holders of existing cryptocurrencies (such as Bitcoin or Ethereum), or may be “earned” by posting to social media or referring the cryptocurrency to other users.
An attorney in the IRS Office of the Associate Chief Counsel clarified in recent comments that promotional airdrops are not within the scope of Revenue Ruling 2019-24, but also noted that the IRS had not yet reached a decision on the tax treatment of these airdrops
- Valuation and receipt issues for airdropped coins
If coins of a new cryptocurrency are “received” for tax purposes, the owner of the cryptocurrency is required to include in its taxable income the fair market value—generally, the trading price—of the cryptocurrency at the moment of its receipt. An attorney for the IRS speaking before a recent conference of the American Institute of CPAs (AICPA) in Washington, D.C., suggested that a limited market for new coins may affect their valuation and that a zero valuation may be appropriate for a cryptocurrency that cannot be disposed of at all.
The same attorney also noted that, depending on the specific facts, a taxpayer may be treated as actually or constructively receiving coins of the new cryptocurrency distributed in a hard fork even if it is necessary for the taxpayer to download new software or undertake some other ministerial-type action to accept (or later to transfer) the cryptocurrency. Taxpayers cannot avoid or delay a taxable event simply by declining to accept the airdropped coins.
On December 10th, 2018, a U.S. District Judge for the District of New Jersey denied Latium Network, Inc. (“Latium”) and its co-founders’ motion to dismiss a class action alleging violations of Section 5 of the Securities Act of 1933 (the “Act”) for offering and selling unregistered securities in the form of Latium X (“LATX”) tokens.
U.S. District Judge Raymond Dearie of the Eastern District of New York has ruled that initial coin offerings (ICOs) may be subject to securities law. The ruling came in the court’s denial of defendant Maksim Zaslavkiy’s motion to dismiss an indictment that alleges that he committed securities fraud for selling tokens that he claimed represented shares in a real estate venture and a separate diamond business. Zaslavskiy’s motion to dismiss argued that the investment schemes and their related ICOs did not involve securities and are beyond the reach of federal securities laws and that the securities laws, specifically the Exchange Act and SEC Rule 10b-5, are unconstitutionally vague as applied to this case.