Yesterday, the United States Securities and Exchange Commission sued Kik Interactive Inc, a Canadian company, for “…conducting an illegal $100 million securities offering of digital tokens.”
Here is the SEC Press Release.
The issuance of “tokens” has been a supercharged issue in the cryptocurrency world for some time as the issuers contend these tokens are not securities — therefore not subject to the requirements to issue a US SEC Form S-1, Registration and to provide quarterly, annual reports as well as reports of material events — while the SEC says maybe they are.
In any event, the issue has been out there for some time.
Many crypto advocates have suggested it will take a legal confrontation, like this one, for the issue to be resolved. Well, fellas, you got your wish.
The SEC is focused on the implications of what happens or doesn’t happen when a “security” is registered and issued.
Specifically, they contend, “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.”
Keep that “information” nugget in the front of your brain as you read deeper into this post.
The SEC’s view is that it is the securities issuing regulations and compliance therewith that provides the appropriate protections for investors. The requirements as noted above are:
1. The issuance of a US SEC Form S-1, Registration Statement — filed with the SEC for comment and revision prior to issuance and thereby providing a platform upon which to make disclosures about the financial health of the issuer, discuss risks and other information a buyer would find of vital interest.
2. The filing of quarterly reports, annual reports, and reports of “material” events and actions.
This would, in essence, create a public security. It is not end of the world. You cannot even see it from there.
So what, Big Red Car? What can the SEC do to Kik?
We are starting at the end of the process, dear reader, but it is a good place to start because the stakes are high. [I note that all good fiction editors say, “Create ‘stakes’ that will draw the reader into the story. Make them big and deadly.” Hit the target on that.]
The penalties may include:
1. A permanent injunction against the issuance of tokens or other objectionable actions;
2. Disgorgement of funds raised plus interest;
3. Financial penalties;
4. A bar against certain principals from serving as public company officers or directors;
5. A bar against certain principals from participating in any offering of digital or other securities.
In addition to a civil procedure that alleges fraud and registration violations, this may morph into a criminal case as happened in the Centra Tech, Inc case in which the CTR Token began to unravel ending up with fake business relationships, celebrity endorsements, instantly converting credit cards (converting CTR Token into USD).
Other cases provide “persuasive authority,” Big Red Car?
The CTR Token case alleges very bad acts by very bad actors, who have all now been indicted. [I am not suggesting any equivalence between the two cases.]
A Florida Southern District Federal district court Judge, Andrea Simonton, ruled (in a tangential matter involved with CTR Token celebrity endorser Floyd Mayweather — hey, who wouldn’t invest in something that Floyd Mayweather endorsed? — that the CTR Token was a security based on the application of a long standing SCOTUS precedent that arrived at a test called the Howey Test.
The Howey Test is a four-pronged test that provides an insight into whether a purported instrument is a “security” as the US SEC uses that word.
Here is the Howey Test as explained on the US SEC’s website. This assessment tool has been around for a long time, since 1946.
Here is another bit of chatter on the Howey Test, but written in a different style.
How did we get here, Big Red Car?
Kik started life as a company dedicated to connecting the world through chat. They launched a chat platform and operated out of headquarters in Waterloo, Ontario, Canada and had offices in NYC, Tel Aviv, and Toronto.
The chat business didn’t grow any unicorn horns, so Kik decided to hurl a “hail Mary pass” and pivot toward crypto. They were out of money having burned through venture capital funding and were staring down the barrel of a shutdown. They had put themselves up for sale and had missed with seven promising buyers.
To put the pre-pivot performance of Kik into perspective, they had monthly expenses of $3MM per month at a time when annual revenue FY 2017 was $1.5MM.
If your annual revenue is $1,500,000 and your annual expenses are $36,000,000 — yes a Hail Mary pass may be the only game in town.
So, they pivoted and put together an ICO offering for $100MM in September 2017. Ultimately, US citizens wrote checks for $55,000,000.
The US SEC came calling two days after the ICO issuance and they had the same complaint that flavors the stew today — this was a securities offering based on a Howey analysis.
This is the big disagreement:
1. Sayeth Kik, “It’s a currency.”
2. Sayeth the US SEC, “We applied the Howey test and this is a security.”
Of course, places like Tech Crunch say this is just more of the US SEC’s “war on cryptocurrency companies.”
Wells Notices and Responses
After that there was a long dialogue ending in what is called a Wells Notice, the US SEC’s target letter letting a company know they are going to charge the company with a violation. One has to assume that a years long dialog exhausts the arguments on both sides. Everybody is on a first name basis.
Kik is represented by world class lawyers and spent $5,000,000 on legal fees — more on that later.
The company then has a month to file a rebuttal or additional evidence. This is called a Wells Response.
“Wells Notice, please meet Wells Response.”
Here is a copy of the Wells Notice and Response:
Now, the US SEC takes up to six months to decide whether the target will be charged.
Charges alleged, lawsuit filed by the US SEC
Yesterday, the suspense was ended when the US SEC filed a lawsuit alleging the violation of anti-fraud provisions and registration violations. Pretty standard fare.
Here is the actual Complaint. With Federal electronic filings, you can get this stuff as fast as the lawyers.
The Buzz, Big Red Car?
Of course, there’s been a ton of buzz and zealotry. But, the lawsuit opens Pandora’s Box and Pandora hasn’t been telling the truth, say some very learned folks, like Coincenter.org.
Here is a missive from them on the subject: On SEC v Kik
Sayeth, Coincenter, “Y’all got some ‘splaining to do, Kik, cause the lawsuit is based on different ‘facts’ than y’all have been spouting.”
The big issues are this:
1. Kik was broke as a joke as noted above. Kik had never been profitable. There was no plan to increase revenue — it was a “hail Mary pass.”
2. Kik had pulled its skirt up and tried to attract some interest by showing a bit of ankle — an investment bank was retained, thirty-five potential buyers were contacted, seven came courting. Nobody offered a ring.
3. Kik provided different information to private-sale buyers and general sale buyers. For anybody in the investment business this can be troublesome — giving folks different info when they are buying the same thing.
There was a private placement memorandum that disclosed that Kik was losing money and users at a rapid rate. This info was only disclosed to certain investors — not all.
Nobody got any current financial info.
4. Kik monkeyed around with an e-ticket digital sticker to create the impression that Kin was already at work. Head fake, say the regulators.
5. The CEO made multiple public statements that token buyers would make a profit — one of the fundamental tests of the Howey Test. He specifically said, at the June 2017 Bitcoin Meetup in San Francisco — “…people are going to make a lot of money.”
The US SEC says that when you say that kind of thing, you are in the Land of Securities.
6. Kik is a Canadian company. The Ontario Securities Commission told Kik that Kin was a security. This meant that Canadians were barred from the public sale. Americans were not. What is that smell?
These “facts” put the entire debate on a different footing. Already crypto Illuminati are coming out expressing skepticism about Kik.
So, the company having blown through $5,000,000 of their own money decided to form an outfit to take up the mantle of defending the crypto world from the US SEC pirates.
They raised more than $5,000,000 which they intend to use to defend the entire industry — well, to pay their legal fees to defend this lawsuit which with the facts contained in the US SEC’s Complaint is looking a little dicey.
Nice guys letting you pay their legal fees, no?
Bottom line it, Big Red Car
Kik and the crypto world were looking for a fight with United States Securities and Exchange Commission, a test case to go to the mattresses with the mutts at the SEC.
They got it. Unfortunately, it doesn’t look very good now that certain facts have come out.
A lot of smart people have looked at this case, but the Complaint cuts through a lot of crap. If it stands rigorous cross examination, this is not much of a case.
The founders, the management, the Board of Directors, the venture capitalists involved with this shit storm — it’s a shit storm whether Kik wins or loses, but especially if Kik loses — have a lot of questions to answer.
If the finding is “fraud” — who was involved? Who knew what? When?
This is not what crypto needed.
Please approach this with an open mind. Read the Wells Notice, the Wells Response, and the Complaint.
The US SEC has to prove its allegations. Kik is innocent until proven guilty. There has to be evidence. Stay tuned.