The SEC and ICO Buy Groups

  The SEC and ICO Buy Groups 

By: CryptoKitty    

As more and more ICOs offer ‘pre-sale’ discounts and bonuses crypto investors are scrambling to get in on the action. For large ETH holders, there is a significant advantage to buying early. Small investors have largely been left out as dev’s cater more and more to whales, selling sometimes 80% of their crowd sale tokens in an invitation only pre-sale. 

Small investors will not be defeated! Several groups are popping up all over social media. In some cases smart contracts are used to pool funds and execute buys after the group has negotiated a significant discount/bonus directly with the dev team.  Some crafty community members have even started charging fees for getting in on their presale contracts. As long as the fees are disclosed up front, it’s all fair in my book. However, as usual, the scammers are getting in on the action too, cloning group buy contracts and altering the code to steal contributors ETH. ‘Do your own research’, in this case, includes learning how to read the contract code.  

The SEC has not specifically chimed in on investment clubs and/or buy groups with regard to cryptocurrency, however, they have addressed these groups with regard to trading traditional stocks.  The SEC defines an investment group as “a group of people who pool their money to make investments.” As with anything touched by government, this simple definition has several meanings and exceptions. The SEC identifies two regulations that may apply.   

• Under the Securities Act of 1933,      membership interests in the investment club may be securities. If so, the      offer and sale of membership interests could be subject to Federal      regulation.
   
• Under the Investment Company Act of      1940, an investment club may be an investment company, and regulated.

With regard to the Securities Act of 1933, if your buy group charges a fee, this may be considered a membership interest. If that membership interest, in any way, meets the definition of an investment contract, the group is required to register with the SEC. Generally, a membership interest is an investment contract if members invest and expect to make a profit from the entrepreneurial and managerial efforts of others. This is where it gets tricky and why charging membership fees may lead to legal trouble.   

The SEC has clarified this further: “If every member in an investment club actively participates in deciding what investments to make, the membership interests in the club would probably not be considered securities. If the club has any passive members, it may be issuing securities.”  Please note that it says ANY passive members. This means if you have a few lurkers in your group who paid for memberships but do not contribute to the group, they are relying on the ‘managerial efforts of others’ and expect to make profit, your membership interest is now a security and if not registered as such, may be illegally trading securities.   

As always, there are exceptions under the Securities Act of 1933, sometimes offers and sales of securities do not have to be registered because they are exempt under the law. For example, a non-public offering is exempt. If your group is advertised, if links to your group are posted on social media (reddit, 4chan, etc.), you may be making a ‘public offering’ of your security (membership interest). However, if your group is 100% private, invitation only, just a group of known friends or family, you may be able to collect a membership fee and carry on without fear from SEC interference.   It is acceptable and not uncommon for investment groups to form LLCs. This is beneficial as long as all members of the group are also part of the LLC. If only one or a few members are listed on the LLC, those persons could be considered managers, who may be required to register with the SEC.   

The Investment Company Act of 1940 is the second regulation referred to by the SEC with regard to buy groups.  “An investment club must register with the SEC as an investment company under the Investment Company Act of 1940 if all of the following three conditions apply: 

1. The club invests in securities,  

2. The club issues membership interests that are securities (see above), and  

3. The club is not able to rely on an exclusion from the definition of investment company.”    

Under the above Act, a ‘private investment company” may not need to register with the SEC. To qualify for an exemption, the investment club must not make, nor propose to make, a public offering of its securities and it must not have more than 100 members. If your buy group does not offer membership interest and has less than 100 members, it would be qualified to claim this exemption.     

In summary, there are well established laws and regulations governing investment groups in the United States. The fact that these laws do not specifically address cryptocurrencies is irrelevant as the SEC has already determined that some currencies and tokens are, in fact, securities. If you group is charging a membership fee, the fact that you are buying stocks, crypto or pieces of art doesn’t matter, because the membership fee itself may be considered a public offering of a security. If every single individual member is not actively participating in the groups decisions, that fee could become a serious legal problem.    

If your group does not charge a membership fee, you are in a much safer position legally. Even without a membership fee, groups that make promises or publicly speculate as to the future value of tokens could get themselves into trouble as well. Be weary of lurkers who do not participate in group decisions, you could be found to be making investment decisions on behalf of these people.  My number one piece of advice for those seeking to get involved with group buys is to learn to read a little code yourself or find someone you trust to review the contracts for you. Changing one line of code can turn a legitimate contract into a scammers dream.

 Good luck and stay safe!    

Most of this information was obtained directly from the SEC's website.  Please check here for further information (DYOR) https://www.sec.gov/reportspubs/investor-publications/investorpubsinvclubhtm.html

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