The SEC issued a cease and desist order against Munchee’s $15 million ICO, opining that the tokens were securities for which no there was registration statement filed or in effect with the Commission nor a qualifying exemption from registration.
In support of its opinion, the SEC stated that a purchaser of the tokens would have had a reasonable expectation of obtaining a future profit based upon Munchee’s efforts, including Munchee revising its app and creating an “ecosystem” using the proceeds from the sale of the tokens. According to the SEC, even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labelling – such as characterizing an ICO as involving a “utility token” – but instead requires an assessment of “the economic realities underlying a transaction.” All of the relevant facts and circumstances must be considered in making that determination.
On the second day of sales of MUN tokens, the company was contacted by Commission staff. The company determined within hours to shut down its offering, did not deliver any tokens to purchasers, and returned to purchasers the proceeds that it had received. This is a prime example of why it is critical to ensure legal compliance if you plan to do an ICO.
By way of additional background, Munchee built a restaurant review app and offered Ethereum-based tokens (“MUN”) so that it could improve its existing app and recruit users to eventually buy advertisements, write reviews, sell food and conduct other transactions using MUN. In connection with the offering, Munchee described the way in which MUN tokens would increase in value as a result of Munchee’s efforts and stated that MUN tokens would be traded on secondary markets.
The MUN White Paper referenced the SEC’s DAO Report and stated that Munchee had done a “Howey analysis” and that “as currently designed, the sale of MUN utility tokens does not pose a significant risk of implicating federal securities laws,” but provided no analysis. According to the SEC, while Munchee told potential purchasers that they would be able to use MUN tokens to buy goods or services in the future after Munchee created an “ecosystem,” no one was able to buy any good or service with MUN throughout the relevant period. Munchee also said it would work with restaurant owners so diners could buy food with MUN tokens and so that restaurant owners could reward app users – perhaps those who visited the restaurant or reviewed their meal – in MUN tokens. As a result, MUN tokens would increase in value.
Some additional points from the SEC legal analysis include the following:
- Munchee offered and sold MUN tokens in a general solicitation that included potential investors in the United States. Investors paid Ether or Bitcoin to purchase their MUN tokens. Such investment is the type of contribution of value that can create an investment contract.
- MUN token purchasers had a reasonable expectation of profits from their investment in the Munchee enterprise.
- The proceeds of the MUN token offering were intended to be used by Munchee to build an “ecosystem” that would create demand for MUN tokens and make MUN tokens more valuable. In addition, Munchee highlighted that it would ensure a secondary trading market for MUN tokens would be available shortly after the completion of the offering and prior to the creation of the ecosystem.
- Investors’ profits were to be derived from the significant entrepreneurial and managerial efforts of others – specifically Munchee and its agents – who were to revise the Munchee App, create the “ecosystem” that would increase the value of MUN (through both an increased demand for MUN tokens by users and Munchee’s specific efforts to cause appreciation in value, such as by burning MUN tokens), and support secondary markets. Investors had little choice but to rely on Munchee and its expertise. At the time of the offering and sale of MUN tokens, no other person could make changes to the Munchee App or was working to create an “ecosystem” to create demand for MUN tokens.
- Investors’ expectations were primed by Munchee’s marketing of the MUN token offering. To market the MUN token offering, Munchee and its agents created the Munchee Website and the MUN White Paper and then posted on message boards, social media and other outlets. They described how Munchee would revise the Munchee App and how the new “ecosystem” would create demand for MUN tokens. They likened MUN to prior ICOs and digital assets that had created profits for investors, and they specifically marketed to people interested in those assets – and those profits – rather than to people who, for example, might have wanted MUN tokens to buy advertising or increase their “tier” as a reviewer on the Munchee App. Because of the conduct and marketing materials of Munchee and its agents, investors would have had a reasonable belief that Munchee and its agents could be relied on to provide the significant entrepreneurial and managerial efforts required to make MUN tokens a success.
- In determining to accept the Offer, and to not impose a civil penalty, the Commission considered remedial acts promptly undertaken by Munchee and cooperation afforded the Commission staff.