On July 25, 2017, the Securities and Exchange Commission (“SEC”) issued a Report of Investigation (“Report”) finding that the digital tokens offered and sold by the virtual, unincorporated organization known as “The DAO” were securities subject to the federal securities laws. The DAO sold DAO tokens in exchange for the digital currency Ether used on the Ethereum blockchain. The DAO expected to use the estimated $150,000,000 in Ether it raised to fund digital projects, while purchasers of the DAO tokens expected a return on their investment by sharing in the earnings from the funded projects. Holders of DAO tokens could also re-sell their tokens on a number of web-based platforms that supported secondary market trading in DAO tokens.

The DAO is an early example of an Initial Coin Offering (“ICO”), a type of crowdfunding in which investors purchase digital “coins” or “tokens” distributed via blockchain/distributed ledger technology (“DLT”) with fiat or digital currencies, and the blockchain/DLT company issuing the digital coins or tokens uses the proceeds to fund its business activities. For more information on ICOs, see the SEC’s investor bulletin on the subject.

In the Report, the SEC for the first time deemed a digital asset a security, and illuminated several factors the SEC will consider in determining whether a given digital asset constitutes a security. Although the SEC declined to bring an enforcement action in this instance, it noted that parties transacting in DAO tokens may be liable for violations of federal securities laws, and further that exchanges which provide for trading in DAO tokens must register with the SEC unless they are otherwise exempt. The SEC cautioned market participants that other offers and sales of digital assets may be subject to federal securities laws, depending on the characteristics of each asset, along with the facts and circumstances surrounding their offer and sale.

The SEC found that DAO tokens were securities – more specifically that they were investment contracts. As the SEC noted in the Report, federal securities law treats an investment contract as “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial expertise of others.” See SEC v. Edwards, 540 U.S. 389, 393 (2004); SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946). In reaching its determination, the SEC made the following findings:

  • The purchase of DAO tokens with Ether was “an investment of money,” as it constituted the contribution of value that can create an investment contract.
  • Promotional materials told investors that the DAO was for-profit, and would offer a return on money invested.
  • DAO tokenholders’ profits derived from the managerial efforts of others. The founders held themselves out as experts in investing on the Ethereum blockchain, leading investors to believe they could be relied upon for success. The DAO’s “Curators” held significant power over the operations of the DAO. Consequently, the founders and “Curators” played roles essential to the success or failure of the enterprise.
  • DAO tokenholders’ rights were limited. They were substantially reliant on the managerial efforts of the founders and Curators. Furthermore, DAO tokenholders were widely dispersed and had limited means of communication, which weakened their ability to exercise meaningful control.

The SEC emphasized that its findings regarding the DAO were limited to the instant case, and that any determination of whether or not a given digital asset is a security will be based on the facts and circumstances. It further encouraged market participants to constructively engage with the SEC and ensure that they are in compliance with the relevant securities laws.

Photo of David Stein David Stein

David Stein advises clients on credit reporting, financial privacy, financial technology, payments, retail financial services, and fair lending issues. He assists a broad range of financial services firms, consumer reporting agencies, financial technology companies, and their vendors with regulatory, compliance, supervision, enforcement, and…

David Stein advises clients on credit reporting, financial privacy, financial technology, payments, retail financial services, and fair lending issues. He assists a broad range of financial services firms, consumer reporting agencies, financial technology companies, and their vendors with regulatory, compliance, supervision, enforcement, and transactional matters.

Mr. Stein has significant experience advising clients on compliance with the FCRA, GLBA, ECOA, EFTA, E-Sign Act, TILA, TISA, FDCPA, Dodd-Frank Wall Street Reform and Consumer Protection Act, and FTC Act, as well as state financial privacy laws. Mr. Stein is a member of the firm’s fintech and artificial intelligence initiatives and works with clients on issues related to cutting edge technologies, such as blockchain, virtual currencies, big data and data analytics, artificial intelligence, online lending, and payments technology.

Mr. Stein previously served in senior regulatory, policy-making, and management positions at the Consumer Financial Protection Bureau (CFPB) and the Federal Reserve Board (FRB). He played a significant role in developing regulations and policy on credit reporting, financial privacy, retail payments systems, consumer credit, fair lending, overdraft services, debit interchange, unfair or deceptive acts or practices, and mortgage origination and servicing. Mr. Stein draws upon his government experience in representing clients before the CFPB, the FRB, and other regulatory agencies and leverages his insights into the regulatory process to provide clients with practical, actionable advice.

Photo of Mike Nonaka Mike Nonaka

Michael Nonaka is co-chair of the Financial Services Group and advises banks, financial services providers, fintech companies, and commercial companies on a broad range of compliance, enforcement, transactional, and legislative matters.

He specializes in providing advice relating to federal and state licensing and…

Michael Nonaka is co-chair of the Financial Services Group and advises banks, financial services providers, fintech companies, and commercial companies on a broad range of compliance, enforcement, transactional, and legislative matters.

He specializes in providing advice relating to federal and state licensing and applications matters for banks and other financial institutions, the development of partnerships and platforms to provide innovative financial products and services, and a broad range of compliance areas such as anti-money laundering, financial privacy, cybersecurity, and consumer protection. He also works closely with banks and their directors and senior leadership teams on sensitive supervisory and strategic matters.

Mike plays an active role in the firm’s Fintech Initiative and works with a number of banks, lending companies, money transmitters, payments firms, technology companies, and service providers on innovative technologies such as bitcoin and other cryptocurrencies, blockchain, big data, cloud computing, same day payments, and online lending. He has assisted numerous banks and fintech companies with the launch of innovative deposit and loan products, technology services, and cryptocurrency-related products and services.

Mike has advised a number of clients on compliance with TILA, ECOA, TISA, HMDA, FCRA, EFTA, GLBA, FDCPA, CRA, BSA, USA PATRIOT Act, FTC Act, Reg. K, Reg. O, Reg. W, Reg. Y, state money transmitter laws, state licensed lender laws, state unclaimed property laws, state prepaid access laws, and other federal and state laws and regulations.