By Josiah Wilmoth
The Massachusetts Securities Division has filed charges against an initial coin offering (ICO) operator who it claims violated securities and business laws.
Massachusetts Regulators File Charges Against ICO Operator for Violating Securities Laws
The division accuses Brookline, MA, resident Kirill Bensonoff and his company, Caviar, of operating an unregistered security offering through an ICO that reportedly raised more than $3 million before regulators halted it.
Caviar intended to use the ICO proceeds to launch a hedge fund, shares of which would trade on cryptocurrency exchanges. Bensonoff registered Caviar in the Cayman Islands, most likely due to its loose regulatory environment.
However, the company had no physical presence there and he admitted in testimony to operating the company out of his home, which places it under the purview of both state and federal regulations governing securities offerings.
The complaint said that Bensonoff neither registered the Caviar ICO nor obtained an exemption from the state.
The ICO, which began in Dec. 2017, purportedly excluded US residents from purchasing caviar tokens. However, the complaint alleges that the screening process was insufficient to prevent US investors from contributing.
“This serves as a warning to those who would try to use the recent bitcoin craze to circumvent securities laws in Massachusetts,” the Boston Herald quoted Secretary of the Commonwealth William Galvin as saying.
“My Securities Division will be monitoring these cases closely to ensure Massachusetts investors are not being taken advantage of by so-called ICO (initial coin offering) promoters trying to cash in on the latest get-rich-quick scam,” he added.
Caviar’s Red Flags (And How to Avoid Them)
Indeed, the case should serve as a warning for startups who desire to launch a token generation event (TGE)* to bootstrap the development of their products.
While Bensonoff maintains that he does not believe Caviar violated Massachusetts regulations, the division’s complaint details several key mistakes that startups should avoid if they hope to avoid facing a similar legal predicament.
Developing a Security Token
The greatest problem was structural. As the complaint demonstrates, caviar tokens clearly fail the Howey Test, which is used to judge whether an asset qualifies as a security.
To wit, the Caviar ICO was nakedly structured as a security, as it referred to token buyers as investors, marketed itself as an investment instrument, and promised shareholders a return on investment.
Both state and federal regulators have stated categorically that they will prosecute security token ICOs that fail to register with the relevant authorities, and Caviar is not the first token sale to be shuttered for failing to do so.
Using Investing-related Marketing
Additionally, Caviar’s marketing materials and token launch website reinforced that the token was a security through references to profits and use of other investment-related terminology. ICO contributors were presented with a button that said “Invest Now,” although the complaint notes that the button was updated to read “Contribute Now” after the division subpoenaed Bensonoff to testify on the matter.
While not as crucial in this specific case since the caviar token was clearly a security, it should serve as a reminder to utility token developers that they must use careful and precise vocabulary and avoid investing-related terminology.
Failing to Properly Vet Token Buyers
Finally, Caviar failed to properly vet contributors to ensure that no US residents contributed to the ICO. According to the filing, an investigator was successfully “verified” and allowed to contribute to the token sale, and there is evidence that at least one other US resident was verified as well, although his contribution was returned since he attempted to invest using a US bank wire rather than cryptocurrency, which is location-agnostic.
Startups who exclude contributors from particular jurisdictions must take great care to ensure that their verification operations are sufficient to prevent unauthorized individuals from participating in the launch.
Most, if not all, of these red flags could have been addressed with the help of one of the growing number of securities lawyers who are knowledgeable about the blockchain space, which is why all startups should make legal and regulatory compliance a chief priority as they approach their token launches.
*In general, the term “initial coin offering” is used to refer to a token launch that involves a security, while “token generation event” refers to utility token sale.
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