The Securities and Exchange Commission (“SEC“) has ruled that Decentralized Autonomous Organization (“DAO“) tokens are security tokens and should have been registered in 2016 with the SEC as such. The complete Report may be viewed here. The SEC also released an Investor Bulletin, which wrote:
The Bulletin also detailed ICOs, including key points to consider when determining whether to participate in an ICO.
Further, The SEC’s Report stated that the DAO, a virtual organization embodied in computer code and executed on a distributed ledger or blockchain, was created by Slock.it, and that:
“The automation of certain functions through this technology, ‘smart contracts’ or computer code, does not remove conduct from the purview of the U.S. federal securities laws.”
Some key takeaways in the SEC’s Report include:
- Foundational principles of the Securities Laws apply to virtual organizations or capital raising entities making use of distributed ledger technology.
- A security includes “an investment contract,” which is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.
- In analyzing whether something is a security, “form should be disregarded for substance,” and the “emphasis should be economic realities underlying a transaction, and not on the name appended thereto.”
- In determining whether an investment contract exists, the investment of “money” need not take the form of cash.
- Investors in the DAO used Ether to make their investments, such investment of this type can create an investment contract.
- The investment may take the form of goods and services as well.
- Investors had a reasonable expectation of profits and profits include “dividends, other periodic payments, or the increased value of the investment.”
- The DAO’s investors relied on the managerial and entrepreneurial efforts of Slock.it and its co-founders, and The DAO’s Curators, to manage The DAO and put forth project proposals that could generate profits for The DAO’s investors; in this way, the investors had little choice but to rely on their expertise.
- The voting rights afforded DAO Token holders did not provide them with meaningful control over the enterprise, because (1) DAO Token holders’ ability to vote for contracts was a largely perfunctory one; and (2) DAO Token holders were widely dispersed and limited in their ability to communicate with one another.
- Issuers must register offers and sales of securities unless a valid exemption applies.
- The definition of “issuer” is broadly defined to include “every person who issues or proposes to issue any security” and “person” includes “any unincorporated organization.”
- A system that meets the definition of an exchange must register as a national securities exchange or operate pursuant to an exemption from such registration.
*It is important to consult an attorney prior to an ICO in order to mitigate any risks and avoid complications with the SEC down the road.