With the rise and rise of initial coin offerings (ICOs), much attention has been paid to how the U.S. Securities and Exchange Commission (SEC) and federal prosecutors view this innovation. And rightfully so, as those enforcement systems carry stiff penalties and even the potential for jail.
But investors and companies should also know that buyers can sue sellers privately under the federal securities laws based on similar theories. Sellers should know about these laws to understand the risks they face, and buyers should know their remedies if treated unfairly.
I wrote this article a few years ago about how to identify whether a coin is a security (back when we were calling ICOs “token pre-sales”), and the bottom line is that it can be tricky. The important thing to know, however, is that if an ICO does constitute a security offering, then federal law requires that the seller register the security or find an exception. Failure to do so can result in SEC enforcement or criminal sanction.
But here’s what not everyone realizes: the Securities and Exchange Act of 1933 says that a person who buys an unregistered security can sue the seller on his own to get his money back. That’s important for a number of reasons.
First, it means that the SEC and the Department of Justice are not the only parties who can allege that an ICO is a securities offering. Some argue these days that there have been so many ICOs and that the SEC is so understaffed that it will never bring enforcement actions against the vast majority of sellers. But this doesn’t mean a private party won’t sue. And if a private person does, it is not the SEC, but a judge who decides if the ICO was a securities offering.
Second, the private right of action is important because the remedy is to entirely unwind the original sale. That means that a company that raised $15 million in its ICO might have to give every penny (satoshi?) back to its buyers, even if it has since spent much of what it raised.
That kind of outcome is also made possible by federal class action rules, which allow one person to sue on behalf of all of the people who bought a particular security…