The Securities and Exchange commission and other government regulatory bodies in the US and elsewhere are turning an increasingly critical eye on initial coin offerings (ICO), the investment vehicle that allows fundraising without surrendering equity. Recently, the SEC charged the two owners of Centra, a company endorsed by boxing champion Floyd Mayweather, with fraud in connection with its ICO last year. The SEC is seeking to claw back $32 million raised in the ICO.

Block Tribune talked with O’Melveny financial services litigator William Pao about Centra and other ICO issues. Pao has written on the “potential tsunami” of cryptocurrecy securities lawsuits and notes that in less than half a year, some 13 cases have been filed across the country challenging ICOs under federal and state securities laws.

BLOCK TRIBUNE: Is Centra a classic example of ICO fraud?

WILLIAM PAO: Yeah,I would call it an example of “pure fraud” because this is a case where we have allegations that the people setting up the ICO essentially promised to do something and that never had any intent to do it. I would say this is one of the examples where, at least based on the allegations, there’s clearly security fraud.

But now, when we’re talking about ICOs, at least in the private litigation space, there has been a lot of complaints filed by plaintiff’s lawyers and those run the gamut. But in terms of whether this is just the emblematic example, at least based on the allegations of security fraud or ICO fraud, I would say that that’s the case.

BLOCK TRIBUNE: How can somebody tell whether an ICO was good or bad? Is there any way?

WILLIAM PAO: I think it’s very important to do your homework. At this stage, this is why the SEC and other regulators are so interested in making sure that proper disclosures are provided to investors. At this stage, there’s a lot of activities going on and a lot of potential bad apples out there. So the only way really is to do your homework and consult with professionals when needed.

BLOCK TRIBUNE: What sort of homework should you be doing?

WILLIAM PAO: I think you have to understand exactly what the ICO is, and what the token proposed to do. There’s a lot of people investing in the space because they have heard about cryptocurrencies and have heard about the meteoric rise in the last months of 2017, and people are just jumping into the space without knowing really what an ICO even is, or what the tokens do. So, foremost, I think it’s important that any investor understand the space, and they have to ask themselves, do they know enough about the proposed ICO to feel comfortable investing their money?

It’s also important to consult with investment professionals and lawyers just to make sure that if you are investing a lot of money, this is something that they feel comfortable investing in.

BLOCK TRIBUNE: Given that most ICOs are based on white papers and sort of big promises, it seemed like there’s almost no way to be sure, unless, of course, you look up and see that somebody has an extensive history of fraud.

WILLIAM PAO: As with anything, I don’t think there’s any way of knowing for certainty whether any investment is a good investment or not. People invest at their own risk.

But with regard to white papers and the way that these things are set up now, because there had been very little regulation in the beginning and, at the least, token issuers were not concerned about regulations, and regulators were not very active in the space, there were a lot of statements made in white papers without much thought.

I think given that the regulators have become much more active in this space and token issuers are aware of this, I think they are a lot more sensitive to what they put in white papers. Hopefully, that would encourage more information to be provided to investors.

But, at the end of the day, if investors are putting their money into the space, like I said, they need to do their homework, and there is a certain amount of risk involved.

BLOCK TRIBUNE: How extensive is ICO fraud? Could we put any percentage on it?

WILLIAM PAO: I think that’s hard to say. There clearly are a few bad apples here and, just based on the allegations and the Centra Tech case, it seems like this could be one of them.

When we’re talking about fraud and examples where people are just promising to do things that they had no intent ever of doing, of trying to sell people on a company that was never really set up in the first place, that is not unique to ICOs, right? So what you have is you have bad apples, you have fraudsters taking advantage of the hype associated with ICOs and cryptocurrencies.

I don’t think that should be associated with ICOs and cryptocurrencies and taken as an indication that all ICOs, or the majority of ICOs, or cryptocurrencies are bad. You have people take advantage of the situation in any type of investment, and in many different facets of life, period, right?

I think it’s hard to say what the percentage is. I think it’s clear because there weren’t a lot of regulations, and there was a lot of hype in the space, and there was a lot of activity, you had bad apples. Those bad apples are being, hopefully, weeded out now and, gradually, I think you’re going to see these allegations of outright fraud come down.

But that’s not to say that enforcement actions or actions filed by plaintiff counsel, whether those numbers will come down, because this is a space that is still developing. The regulatory framework is changing every day. So, notwithstanding the fact that there might not be outright fraud in the space, you can still see a lot of plaintiff’s counsel, and even regulators, testing the limits and filing suit to help define what the regulatory environment should be.

BLOCK TRIBUNE: There are a number of companies out there that are offering turnkey tokenization. What’s your opinion on those?

WILLIAM PAO: I think it’s just important, before you turn to those type of solutions, to make sure that you consult professionals. I think it is very important before you just buy into a turnkey solution to make sure you understand what that turnkey solution is, and what that does.

We’ll have to see how these “turnkey solutions” work out in the regulatory environment. As I’ve mentioned, it’s changing every day, so there are questions whether you can just have a turnkey solution here, and it’s important to do your homework on who’s offering these solutions and whether it’s somebody that you think you can rely on.

But I will say that, given how the regulatory environment, as I mentioned, is changing every day and you have regulators not only in the US, but all across the world, issuing new pronouncements almost on a every couple day or weekly basis, it’s important to stay nimble. Whether a turnkey solution is able to do that, I think that remains to be seen.

BLOCK TRIBUNE: What do you expect to see in the next year in this sector? In the initial coin offerings, do you expect to see more, do you expect to see less tightening regulation, what else?

WILLIAM PAO: I think what is likely is that we’re going to see more regulators become active in this space and continue issuing statements. I think there’s going to be more regulatory actions because it’s clear that the SEC and others have made this an area of priority, especially given the interest that this has gotten and the fact that because this space is so new that it could be susceptible to fraud. So I expect to see a lot more regulatory actions.

Recently, we have started to see, for example, the Department of Justice become active in the space, and they’re now filing criminal cases, and so, I think that’s a relatively new development. But I expect them to be much more active.

BLOCK TRIBUNE: Why were regulators so late to the game on this? This had been going for now at least a year and a half, if not longer, and now, it’s only late in the fall that they started to seemingly gain traction in this sector. Why were they so late on this?

WILLIAM PAO: I don’t know if I would say that they’re necessarily late to this. I think they were monitoring events. I think it was really last year where cryptocurrencies and ICOs really began to take off, at least in terms of the general public, where you have much more people investing in tokens and you saw the meteoric rise in cryptoprices last year. I think that really got the regulator’s attention.

To their credit, I think they want to proceed carefully here because, on the one hand, I think they want to protect investors and people that are investing potentially their life savings in cryptocurrencies. But on the other hand, they also don’t want to stifle development, and you have a lot of regulations in place that were not necessarily intended to be applied to this type of technology. I think it requires a careful balancing to decide how regulation should apply to this space and particularly to ICOs. I think they have slowly issued pronouncements, and I think that has gathered steam in the last couple of months, and they’ve filed now enforcement actions.

I think, on the whole, they are very focused on protecting consumers and investors, of course, but I think it’s also a sign that they want to try to let this space grow and not stifle it in the very beginning.

BLOCK TRIBUNE: One of the issues that’s cropped up recently with Centra is about celebrity endorsements. I know the SEC have been saying that celebrities have to be aware of what they’re endorsing and there’s certain rules that govern that. What do you see happening? Are there going to be any prosecutions of famous people who’ve endorsed cryptocurrencies?

WILLIAM PAO: I think that’s hard to say for the time being. I will point out that the SEC did issue a statement last year noting celebrity endorsements of ICOs and the SEC specifically said that it’s very important for celebrities to, if they are promoting an ICO, they need to disclose their connections to the ICO and to the token.

But, in addition, they also said that it’s possible that anyone promoting ICOs, including celebrities, could be subject to the anti-fraud provisions of the Securities Regulations and the Securities Exchange Act. I think that is more or less a shot across the bow, but as we say from the Centra Tech case, the celebrities themselves were not named in that suit. I think it’s going to be highly dependent on what the celebrity’s involvement in the promotion is, and what they knew about the alleged fraud. But, as with anything, when you put your name and your face to a particular product, there are going to be some risks involved.

I will add one other thing. I think with celebrities endorsing ICOs, I think that is part of how the hype is generated, right? I think a lot of people that don’t know much about ICOs and cryptocurrencies, when they see a celebrity endorser’s face in particular, there’s a lot of excitement about that. So, that might be one reason why there’s so much hype with regard to a particular token. If that’s the case and the allegations and what bears out show that the celebrities were significantly involved, I think it’s very possible that you can see them named in some action in the future.

BLOCK TRIBUNE: What do you see on the private litigation side in the next year?

WILLIAM PAO: As we mentioned, there’s going to be a lot of enforcement actions and regulatory activity. But it’s also important to not lose sight of the fact that plaintiff’s counsel are very active in the space. Because the regulatory environment is still in the beginning stages of development and also how securities laws and other laws apply to ICOs in cryptocurrencies, I think it’s very important not to lose sight of those cases because those cases could very well set the legal framework for ICOs going forward.

One thing I’ll point out also is that, in addition to these early class actions, which challenge whether the tokens constituted securities and whether they needed to register a security, you’re beginning to see the basic consumer class actions, the typical consumer class actions filed against any company now filed against token issuers. I think we’re going to see a lot of activity in the litigation space in the coming months and how all the cases shake out is really going to, in large part, affect the legal framework going forward.