Because the cryptocurrency industry is still so new, there have been a lot of ‘firsts’ over the last several years: the dawn of token sales (in all of their varieties), the first entry of big tech companies into the space; the assortment of power struggles and the new cryptocurrencies that have come with them.
There are also a lot of ‘firsts’ in a legal sense. The cryptocurrency industry is being inundated with court cases and regulatory activity, seemingly with increasing frequency; as such, a number of legal precedents for the industry are constantly in the process of being established.
One of the most signficant court cases so far this year is the battle between the United States Securities and Exchange Commission and Kik, a Canada-based messaging service that held an ICO several years ago.
The SEC has accused the company of holding an illegal securities offering–but not only that: the SEC has also used the court case to slanderously paint Kik as a desperate, irresponsible company that used its ICO as a quick cash-grab. Kik has fired back with a fierce legal defense, as well as a very public criticism of the SEC’s strategies.
But who’s in the wrong here? When it comes to reputation, where should the SEC draw the line between legal proceedings and private opinions? And how can securities regulations be equally and fairly applied when it comes to crypto?
The background: here’s what happened
Kik’s ICO was launched in 2017, and was record-breakingly successful at the time it was completed. More than 10,000 backers contributed 168,732 ETH (worth around $47.5 milllion at the time); a pre-sale round for institutional investors brought in roughly $50 million, making the grand total of funds raised nearly $100 million.
Although the sale’s original goal was $125 million, Kik CEO Ted Livingston seemed to be perfectly happy with the amount that was raised: “We are really excited,” he told TechCrunch in 2017. “If you had told me back in January that we would sell $100 million of a new cryptocurrency in September, I wouldn’t have believed you.”
Flash forward to June of 2019–the US Securities and Exchange Commission filed a lawsuit against Kik Interactive Inc. alleging that Kik’s ICO was an unregistered securities offering.
“By selling $100 million in securities without registering the offers or sales, we allege that Kik deprived investors of information to which they were legally entitled, and prevented investors from making informed investment decisions,” said Steven Peikin, co-director of the SEC’s Division of Enforcement, in an official statement. “Companies do not face a binary choice between innovation and compliance with the federal securities laws.”
Insult to injury
Getting sued by any branch of the US government isn’t exactly a walk in the part on any day of the week, but the real salt in the wound was the seedy light that Kik was painted in: the language in the SEC’s filing depicted Kik as a desperate, money-hungry company on its last legs–a depiction that Kik didn’t take lightly.
For example: although the SEC’s legal claims with regards to Kik are focused on the KIN token’s status as a security, the lawsuit also seems to insinuate that Kik used the ICO to cover up losses incurred throughout 2016 and 2017.
Specifically, the SEC’s filing says that In the wake of rapidly-shrinking revenues, “Kik decided to ‘pivot’ to an entirely different business and attempt what a board member called a ‘hail Mary pass’: Kik would offer and sell one trillion digital tokens in return for cash to fund company operations and a speculative new
Could there have been any validity to these claims? According to startup technology consultant David Pring-Mill, the company could have been desperately searching for a way to differentiate itself from other messaging services, particularly Facebook’s.
“Some politicians and regulators have suggested that Facebook has effectively monopolized digital interactions, so perhaps [the phrase] ‘crowded market’ is understating the dire situation faced by Kik Interactive,” he said to Finance Magnates.
“The word ‘monopoly’ is contestable but it’s very clear that through Facebook’s major acquisitions and even acqui-hires, the company now facilitates messaging across multiple platforms and has mastered the underlying technologies. Facebook’s ginormous revenue and long-term assets also represent a massive competitive edge. All of this means that Kik Interactive’s need to differentiate itself was real and pressing.
Pring-Mill explained that although “presently, the buzz around digital coins has dropped from its previous fever pitch, and the ubiquity and failure of various, coin-based business schemes [has] reduced the perceived novelty of them”, it may be easier for Kik to say that its ICO wasn’t a cash-grab now than it was two years ago.
Indeed, “it’s easy to forget that an original token at one point did confer a corporate marketing advantage and had the potential to attract users toward decentralized yet strategically branded digital economies,” he said. “However, concurrent to this, initial coin offerings allowed for fraud, as well as the rapid influx of cash into companies that had not rigorously or transparently explained the merits of their proposals.”
The SEC went above its jurisdiction to criticize Kik’s business plan
But why would the SEC feel the need to moralize Kik’s behavior when its public obligations are specifically related to securities regulations, and nothing more?
Indeed, while there could be some validity to the SEC’s criticism, Virtual currency attorney Braden Perry pointed out to Finance Magnates that it has “the SEC went out of their way to judge the business actions and model of KIK, which is outside of its jurisdiction, especially where no fraud is alleged.”
Jay Arcata, BX3 Capital’s VP of client relations, told Finance Magnates that the criticism could be an attempt to sway public opinion: “…the inclusion of language insinuating that Kik was engaged in a cover up is certainly intended to sway the reader into believing that Kik’s motives were nefarious.”
“To its credit, the SEC collected large volumes of emails and testimony to make its case,” said Pring-Mill. However, “Kik Interactive alleges that the volumes have merely enabled the regulator to cherrypick quotes and misrepresent documents.”
Kik accused the SEC of “twisting the facts”
In response to the lawsuit and its offending tone, Kik seems to have pulled out all the stops in its efforts to fight back against the SEC. The counter-attack began with yet another fundraising effort (nevermind that Kik’s valuation was estimated at $1 billion in 2018.) The name ‘Defend Crypto’ was given to a fund that was designated specifically for the purpose of battling the SEC in court–a fund that has gone on to assist other crypto companies in need of legal help, a factor that has helped Kik reframe its legal battle as a valiant effort to bring justice to the crypto industry.
— DefendCrypto (@DefendCrypto) June 4, 2019
However, a number of analysts have said that the fund is unlikely to have a major effect on the legal proceedings of the case. “The chance of the Howey Test going the way of all flesh as a result of a $5 million litigation fund is slim to none and slim just left town,” tweeted lawyer and self-described “toxic minimalist” Stephen Palley in regards to the formation of Defend Crypto. “But you do you.”
In addition to the fund, however, Kik’s 131-page formal response to the commission’s lawsuit last week “included a lengthy ‘introduction’ in its answer, aggressively counterpunching the SEC for misstating and twisting the facts, which form the basis of its complaint,” Arcata said.
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Our full response to the SEC complaint: https://t.co/l0wlfFcwef
— Kik (@Kik) June 4, 2019
Specifically, the response reads that “the Commission’s Complaint reflects a consistent effort to twist the facts by removing quotes from their context and misrepresenting the documents and testimony that the Commission gathered in its investigation.”
“The result is a Complaint that badly mischaracterizes the totality of the facts and circumstances leading up to Kik’s sale of KIN in 2017,” the rebuttal continues. “These tactics may have gotten the Commission a decent news cycle, but they will not withstand meaningful scrutiny at summary judgment or trial.”
This kind of frankness “is a tactic in which we do not typically see defendants engage,” Arcata told Finance Magnates. “In the normal course, an answer contains either a straightforward admission or denial of the facts as pled, along with any affirmative defenses that the defendant intends on pursuing.” In other words, the defendant usually either pleads guilty or files a motion to dismiss the case.
Kik, however, seems to be trying to level with the SEC–perhaps even going so far as to call the commission’s bluff.
But how will this eye-for-an-eye language effect on the future of the case? Perhaps not as much as it might seem: “at the end of the day, the effectiveness of Kik’s defense strategy will have little to do with the aggressive introductory paragraph in its answer, and everything to do with the actual facts and circumstances of Kik’s token issuance and whether it meets the definition of a security under the Howey Test,” Arcata explained.
”Kik may have a chance in prevailing.”
And can KIN tokens be qualified as securities? Perhaps–but it depends on how the Howey Test is applied.
Arcata said that in its rebuttal, Kik claims that the SEC is applying the test too liberally: “[Kik stated[ that the SEC incorrectly assumes that any discussion of a potential increase in value of an asset—in this case the Kin token—is the same as promising profits solely from the efforts of others, which is a prong of Howey.”
Indeed, the SEC’s filing claims that “From the initial May 2017 announcement through September 2017, Kik relentlessly pitched Kin and the prospect that Kik’s future efforts to develop the Kin Ecosystem would drive an increase in Kin’s value. Kik emphasized that only a finite number of tokens would be created and that rising demand for the tokens would cause their value to appreciate.”
He explained that Kik has refuted this claim, saying that “KIN was architected, marketed and designed as a currency and not marketed as a passive investment opportunity.”
This may be the company’s only opportunity to win: “if these defenses can be proven with hard facts, Kik may have a chance in prevailing,” Arcata said.
However, he also noted that “the chances of this case proceeding to trial are very slim.”
‘The vast majority of cases such as this resolve short of trial. If Kik were to prevail at trial, however, it would prove to be a seminal moment in the regulation of cryptocurrencies in this country. It is entirely possible that a new Howey Test as applied to cryptocurrencies would emerge. A Kik victory could also serve as the ‘kick’ in the pants that Congress needs to enact sensible regulation in this space.”
This seems to be precisely what Kik CEO Ted Livingston is hoping for:
Our industry desperately needs a new Howey Test. It is time we get one https://t.co/VYNnZYAtri
— Ted Livingston (@ted_livingston) May 28, 2019
But could this actually happen? Maybe–but again, lawyer Stephen Palley shot down the possibility in another tweet: “the notion that “crypto” as a generic category should have its own special treatment under U.S. securities laws is a special kind of ridiculous,” he said.
‘Enforcement by regulation’
Regardless of how the outcome of the case affects Kik, Braden Perry pointed out that the way that this case proceeds could set some dangerous precedents for the future of regulations and the way they are enforced within the cryptocurrency industry.
“The last thing any industry wants is regulation by enforcement, in which agencies decide that some practices should have been illegal, and instead of declaring it illegal from now on through rulemaking, go back and prosecute the people who were doing it before.”
— Chris Burniske (@cburniske) October 1, 2017
But perhaps equally as problematic is the way that the SEC seems to be handling this particular case: “KIK essentially argues that this is a case of ‘enforcement by regulation’”: that the SEC may be ‘bending’ its interpretation of securities laws to make an example of Kik.
“They [Kik] aren’t wrong,” Perry continued. After all, “the Howey test is notoriously vague and many times based on a case-by-case basis.”
And indeed, preventing this kind of uneven interpretation in the future will likely require a more definitive set of regulations: “I generally do not advocate for additional regulations, but more concrete guidance is necessary for ICO issuance,” Perry said–but it will come at a cost: “that regulatory framework will likely [cause lags in] innovation, and frustrate those willing to adopt new technology.”
Regardless of what’s to come, “for now, it looks like KIK will have to convince the court that Kin was not a security, while rewriting what they believe the facts to be and facing a large legal expense,” Pterry said. “It’s going to be a long battle, with extensive discovery, but the main issue is pretty simple: was this a security or not? And that will be legal issue and likely ripe for a substantive judicial interpretation”–one that could have profound effects on the future.