Earlier this month, the Securities and Exchange Commission (SEC) obtained a temporary restraining order freezing an alleged unregistered digital token offering by a messaging service.  The SEC alleged that the defendants violated the registration requirements of the Securities Act of 1933 by conducting a securities offering through a sale of digital tokens, without registering the offer and sale of the digital tokens (or relying on an exemption from the registration requirements).

The defendants raised more than $1.7 billion since the launch of the offering through the sale of approximately 2.9 billion digital tokens, including more than 1 billion digital tokens to U.S. purchasers, which were sold to these initial investors at discounted prices. The defendants have been using the funds to finance their operations, which includes the development of a blockchain network and a mobile messaging application.

The defendants had promised investors to deliver the digital tokens upon the launch of the blockchain network by no later than October 31, 2019, at which time purchasers and the defendants would be able to sell additional digital tokens into U.S. markets.  The SEC alleged that because purchasers “expect to profit” from the functionalities that are being built using funds from the digital token offering through an increase in the value of the digital tokens sold to them, the defendants conducted an offering of securities, which they failed to register with the SEC.  The SEC also alleges that the digital tokens cannot be considered a currency because no products or services can be purchased using the digital tokens.

Shortly after the SEC’s announcement, the defendants announced that they are planning to delay the launch of the blockchain network until April 30, 2020.

Stephanie Avakian, Co-Director of the SEC’s Division of Enforcement, stated that the action is meant to prevent the defendants from “flooding the U.S. markets with digital tokens that [the SEC] allege[s] were unlawfully sold,” while her Co-Director Steven Peikin added that “issuers cannot avoid the federal securities laws just by labeling their product a cryptocurrency or a token.”

This is one of several recent high-profile enforcement actions in the digital asset space, and it is clear that federal regulators are continuing to closely monitor whether such offerings are in compliance with federal securities laws.