SEC issues warning on initial coin offerings

The Securities and Exchange Commission took its first steps to rein in startups that have raised money by selling their own virtual currencies, a growing trend known as initial coin offerings.

The agency said Tuesday that it had concluded after an internal investigation that at least some virtual currencies being sold to investors should be categorized as securities and needed to follow federal securities laws.

Since the beginning of the year, startups and entrepreneurs have raised more than $1 billion by selling custom-made virtual currencies to investors in initial coin offerings.

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Most companies selling virtual currencies in recent months have done so with little regulatory oversight and have not made any effort to comply with securities laws, which, among other things, requires companies to disclose information about their operations before collecting money from U.S. investors.

Many lawyers have warned that the fundraising method was likely to draw attention from regulators. The announcement Tuesday suggested that the agency was likely to scrutinize both past and future coin offerings.

“The writing is on the wall for many recent ICOs: The SEC is coming,” said Brian Klein, a former federal prosecutor who now works at the law firm Baker Marquart.

The price of virtual coins that have recently been sold to investors dropped sharply after the announcement came out Tuesday, according to the exchanges where they are bought and sold.

The SEC did leave open the possibility that some coins could be devised so that they are not defined as securities, depending on the “economic realities of the transaction.”

Lawyers have said that coins could avoid being categorized as securities if they do not promise any returns to investors and do not represent any sort of ownership in the company that creates the coin, among other attributes.

The SEC focused its report on the Decentralized Autonomous Organization, a project that raised nearly $150 million in 2016 before quickly succumbing to hackers. The project aimed to raise money from investors and then invest it in other projects, like a leaderless venture capital fund.

The regulators said Tuesday that the tokens sold by the organization were indeed securities, but they added that they would not bring charges against the organization’s creators.

Still, the announcement made it clear that the agency could decide to go after other projects as well as the exchanges where the digital currencies are bought and sold. Only registered securities exchanges are allowed to offer securities for sale, the SEC said.

Some companies could devise their initial coin offerings to comply with securities law, which would probably limit significantly the number of investors who could participate.

Companies could also seek to bypass the rules by not offering the coins to U.S. investors, which would also limit the potential number of investors.

Nathaniel Popper is a New York Times writer.