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USA: allegations of unregistered securities in Initial Coin Offering.

BIScom Subsection: 
Author: 
Nigel Morris-Cotterill

One would have thought that Initial Coin Offerings had been a flash in the pan and already out of fashion. And that may, to a point, be so: their heyday was, of course, three or four years ago.

But the essential problem seems to be that things take a while to filter through so that, when stories reactivate interest, everything old becomes new again, to coin a phrase. So the news that a case relating to conduct in 2017 and 2018 may be the spark that reignites burning embers as some people remember the concept of the ICO and think "that might be a way to help my business that's struggling through the CoVid-19 Pandemic.

An initial coin offering or ICO is a simple concept. Instead of selling new issue shares, a business creates a new cryptocurrency and sells that, putting the proceeds into the company. Where it goes wrong is when the company seeks to relate the value of the coin to the value of the business when, in fact, there is no direct financial correlation: indeed, the "coin" is nothing more than a product the company sells. There is only an emotional connection between the coin and the business and, therefore, the value - or not - of the coin. The "investment" value of the coin depends on interest in the coin which has a life entirely independent of the business to the extent that, unlike shares, it survives the business. Also, unlike shares, companies do not make a distribution to the holders of coins, even if the company closes with a surplus of moneys.

That uncomplicated position was fundamentally misunderstood by pretty much everyone when ICOs became popular.

John Wise, the CEO of an IT company called Loci, Inc, decided that an ICO was a route to capital raising that was easier, cheaper and quicker than taking the company public. And, of course, unlike shares, ICOs were fashionable, the Non-Fungible Tokens, or NFTs of their day. This is the story of what happens when the SEC decides a small business broke the rules, even though, apparently, that decision was made retrospectively.

Loci operated a software service called InnVenn. It searched intellectual property databases on behalf of inventors. It claimed that it "empowers inventors to discover, claim ownership and sell" rights. On 10 November 2017, it tweeted "blockchain is critical to the securitisation of intellectual property because it guarantees validity of a transaction." But it didn't write it: the tweet links to an article by Amanda Ciccatelli at IPWatchdog.com on 9th October 2017. That article, incidentally, prefaced the interest in NFTs.

But it also prefaced the problems: "Mayweather has the distinction of being the first paid celebrity digital currency sports endorser, helping Stox.com ICO generate over $30 million." In 2018, Mayweather was one of a number of people against whom the SEC brought proceedings for touting unregistered securities in relation to ICOs. Not all hyperbole is touting, it seems: Mark Cuban, an American investor, has a substantial interest in sports betting platform Inikrn (well, it does aim at the e-sports generation). It issued UnikionGold, but not as an ICO, as form of gambling chip in the form of a cryptocurrency. Today, the chip's own website says "Welcome to UnikoinGold, the world's most successful cryptocurrency coin backed by Unikrn. "

Its the "backed by" that gives us pause: that suggests that there is an asset standing behind it. That is dangerously close to what Wise claimed for Loci.

Writing on blog platform Medium in October 2017, Wise explained the Loci InnVenn platform. You can read it here: https://medium.com/@john_Loci/staking-a-claim-in-the-innvenn-marketplace-de9e03a05de3 . In that article he also explained LociCoin - like UnikoinGold based on the Ethereum platform.

This is where Wise went wrong: he sought to build a walled garden for the LociPlatform.

"LOCIcoin is Loci’s unique cryptocurrency that will be used within this Loci ecosystem. By purchasing LOCIcoin, you gain the ability to pay for and use InnVenn, along with Loci products developed in the future. There will only be 50 million LOCIcoin in public circulation.

The only accepted form of payment for IP Portofolios within InnVenn will be LOCIcoin. Because of the 50 milllion LOCIcoin limit, once they belong to individuals, companies looking to purchase IP Portfolios will have to acquire the LOCIcoin needed from these individuals at a price that they set. LOCIcoin are initially being sold at $2.50, but because of supply and demand, that value will rise as Loci develops more products and the supply of LOCIcoin becomes limited."

The thing is, it's not a terrible idea. By creating combines of inventors who identify and enforce their patent rights and collect them into a "portfolio," the portfolio has intrinsic value. Think of it as not entirely dissimilar to the CDOs that Alan Greenspan considered, in 2002, to be the way forward for Wall Street, out of its self-induced dot com crisis.

According to the agreed Order in civil proceedings, "from August 2017 through January 2018, Loci and Wise raised USD7.6 million from investors by offering and selling digital tokens called “LOCIcoin.” ..in promoting the ICO, Loci and Wise made numerous materially false statements to investors and potential investors, including false statements concerning the company’s revenues, number of employees, and InnVenn’s user base...Wise misused USD38,163 in investor['s] proceeds to pay his personal expenses... although LOCIcoins constituted securities, Loci’s offering was not registered with the SEC and no exemption from registration applied."

Without admitting or denying the SEC's findings, Loci and Wise agreed to a cease and desist order and to undertakings to destroy their remaining tokens, request the removal of the tokens from trading platforms, publish the SEC’s order on Loci’s social media channels, and refrain from participating in future digital asset securities offerings. The SEC’s order also imposes a USD7.6 million civil penalty against Loci, and and banned Wise from being a director or officer.

That's all find and dandy, as Americans are wont to say, but..

a) what happens to those coins that are already in the hands of investors: the money that is paid by way of penalty is not, it seems, intended to be for restitution or damages. That leaves both Wise and Loci (insofar as it exists) open to civil proceedings by those who bought them, particularly as they cannot now be traded on exchanges and, inevitably, their value will fall save for novelty value. And even that is limited because you can't put them on a wall.

b) what does "remaining tokens" mean? Does it mean those that have been created but not as yet issued to third parties? There were supposed to be a total of 50 million. There is no information as to how many were in fact issued, only the total value obtained.

c) As of this morning, the Loci InnVenn twitter feed, which was launched in August 2017 and has been dormant since 21 November 2017, does not mention the Order. But it does have a link to a website innvenn.com

InnVenn appears to exist. it has a website and gives its office address as a post-box in Plano Texas. It has a different logo, gives no information as to the company behind the trade name nor the people behind or in the company. But it's not the same InnVenn. "InnVenn has been built with decades of experience in asset management. From adding to tracking, InnVenn has got it all. Generate barcodes for your assets, Assign Assets, Create Projects, Create Teams, Generate reports and a lot more. Experience the future of Asset Management with InnVenn"

It's all very buzzwordy and it's all very stylish with that trendy light-grey on white that makes reading websites so difficult, built in one of those Wordpress themes (except that it's in Bootstrap not Wordpress) that puts everything in one long page. And it's very, very light on detail.

The domain was created in September 2003 and it is due to expire in September this year. The current owner has been "redacted for privacy" and it is hosted at NS1080.UI-DNS.BIZ, NS1080.UI-DNS.COM, NS1080.UI-DNS.DE and NS1080.UI-DNS.ORG. It is registered through Verisign, says ICANN but who.is says the registrar is 1&1 IONOS SE. It was "updated" on 12 March 2018, which more or less coincides with the end of Loci's operations. Who.is says that the domain is registered to Innvenn Associates but no further information is available.

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