Initial coin offerings (ICOs) have sprung up seemingly out of the blue to become the new go-to financing method for up-and-coming startups (often with less than fully sketched out business plans). And a former SEC official has a single question for his former colleagues:
Why aren’t you cracking down on what appears to be a clear violation of securities law?
Joseph Grundfest, a commissioner at the SEC in the 1980s who has since moved on to private life as a business and law professor at Stanford, has become horrified by ICOs — and is dedicated to helping regulators get on the stick and actually start regulating.
“ICOs represent the most pervasive, open and notorious violation of federal securities laws since the Code of Hammurabi,” Grundfest said in an interview. “It’s more than the extent of the violation. It’s the almost comedic quality of the violation.”
The SEC has offered no official comment on Grundfest’s remarks.
ICOs have raked in over $3 billion in funding this year from investors by selling coins that only are valuable or useful for making purchases from the online firms which issued them. They generally do not involve banks or regulators because the coins themselves are not usually bought with cash — but with unregulated bitcoin. And while the SEC has warned that these offerings may be a violation of the law, Grundfest believes this does not go far enough.
“We’re waiting to see a whole bunch of enforcement actions in this space, and we wonder why they haven’t happened yet,” he said. “I hope what they are doing is planning on a sweep of 50 ICOs.”
Chinese and Korean regulators have banned ICOs outright, but in the U.S., so far, the SEC has brought only a single case against a small fraudulent coin offering.
Grundfest is far from the only critic of these offerings. Chamath Palihapitiya, a venture capitalist who is a bitcoin booster, has said he thinks “99 percent of ICOs are a scam.”
Grundfest has also noted the SEC has a fairly obvious way to go after initial coin offerings — label them as securities and punish those who offered them without registering them properly.
The chairman of the SEC, Jay Clayton, mentioned a similar idea earlier this month when he noted that the agency is, in fact, planning to crack down on offerings that violated securities law, including virtual coins that should be categorized as securities.
“Where we see fraud, and where we see people engaging in offerings that are not registered, we are going to pursue them — because these types of things have a destabilizing effect on the market,” Clayton said in a meeting at the Federal Reserve Bank of New York.
Grundfest said that is good news — but news it took too long to get to.
“These are not hard cases,” he said. “You don’t need teams of accountants poring over complex financing documents.”
Grundfest did say that the idea of a coin offering is not without merit for some types of fundraising — firms building a decentralized cloud storage network, for example, could use them as a form of payment and recordkeeping. But, he noted, most of the ICOs that have rolled out so far have not had any kind of novel structure that really required coin use — meaning the likely point of the ICO was just to avoid securities laws.
“Is this amazing technology? Yes,” he said. “But most of the stuff we see today is total crap.”
Grundfest said several teams have approached him on how to do it correctly.
“I say, ‘Look, you are at very high risk for violating the securities law,’ and explain why,” he said. “Then they go find another lawyer.”