On November 16, 2018, the Securities and Exchange Commission (SEC) announced consent orders settling actions in respect of two unregistered initial coin offerings (ICOs), including the first fines levied against non-compliant ICO issuers made by the SEC to date.

The consent orders demonstrate the SEC’s willingness to follow through with enforcement proceedings against issuers of ICOs not in compliance with securities laws, and provide a roadmap for how existing ICOs can bring themselves into compliance going forward.

The parties – Airfox and Paragon

The issuers charged in the two SEC enforcement actions each raised substantial amounts of capital through an ICO for vastly different purposes:

  1. CarrierEQ Inc., doing business as Airfox, is a financial services company focused on emerging markets that raised $15 million in digital assets through an ICO to finance the creation of a token ecosystem by which users would earn and exchange tokens in connection with the acquisition of data and interaction with advertisements;  and
  2. Paragon is an online company that raised $12 million through an ICO with a view to implementing blockchain technology in the cannabis industry.

According to the SEC’s consent orders for Airfox and Paragon, neither company or its ICO was registered with the SEC.  In each case, the SEC charged that the company marketed its ICO on the representation that it expected its coin to appreciate in value with an opportunity for future profit.

Consent orders level heavy penalties and lay out a compliance framework

The penalties leveled against Airfox and Paragon are largely similar, and demonstrate the SEC’s intention to backstop its enforcement of regulation against ICO issuers along with its commitment to ensuring other would-be issuers understand the path to proper compliance.

Both Airfox and Paragon were ordered to pay a civil money penalty of $250,000.  While the Airfox penalty was ordered payable within 90 days, the Paragon penalty is payable in three instalments spread over 240 days.  Airfox and Paragon also undertook in their consent orders to issue press releases notifying the public of the order.

On the compliance side, among other requirements, Airfox and Paragon undertook to register their respective tokens as a class of securities, and to establish a claims process for purchasers of those tokens:  specifically, within 60 days after registering their tokens as securities, each company must notify all purchasers of their potential claims under section 12(a) of the Securities Exchange Act of 1934 including the right to sue to recover the consideration paid with interest for the security, less any income received from that purchase.  Each company is required to provide token purchasers with a claim form, and to pay the amount due pursuant to section 12(a) to each person submitting a proper claim form by the deadline specified in the order, with some opportunity for the company to seek documentation from the claimant to support their claim.  The companies will then have to report the results of this claims process to the SEC on a monthly basis.

SEC orders send clear compliance message

The Airfox and Paragon orders make clear that token issuers that fail to comply with securities laws will (a) be prohibited from profiting from their breaches, (b) face substantial penalties, and (c) end up required to comply with securities laws in any event.  The message is clear: “Comply now, or we will take action to force you to be compliant.”  Anyone considering a token offering with any doubt about the SEC’s willingness to sanction unlawful ICOs should take serious notice.