The Securities and Exchange Commission (SEC) issued an order last week declaring an ICO token to be a security and hence subject to corresponding regulation. Following on from its similar ruling with respect to The DAO on July 25th, the SEC held that Munchee Inc.’s efforts to promote its supposed “utility token” so emphasized the company’s planned efforts to spur the token’s appreciation that the token qualified for regulation as a security notwithstanding its anticipated utility in Munchee’s coming platform.
San Francisco-based tech company Munchee Inc. recently received a cease-and-desist order from the SEC regarding the ICO “ecosystem” model it planned on employing to generate usage and capital. Munchee was designed as an iPhone app that would allow restaurant costumers to review individual dishes, incorporating pictures and descriptions of specific meals instead of offering a general rating like Yelp does, for instance.
On October 31st, 2017, Munchee began to sell its “MUN” tokens issued on the Ethereum blockchain. Munchee’s plan was to issue 500 million total MUN, sell 225 million, and keep the remaining 275 million to improve the app and support its business functionality. This all would contribute to Munchee’s overarching goal of creating a MUN token ecosystem that, once developed, would incorporate the use of MUN tokens to buy goods and/or services.
Munchee intended to pay reviewers in MUN tokens and convince restaurant owners to accept the tokens as payment for meals. This would serve as a reward for restaurant goers who reviewed their meal on the app. Munchee publicized that further efforts to increase the value of the MUN token would include a tier system for reviewers wherein the amount that Munchee would pay users for writing a review would be proportional to the amount of MUN tokens the reviewers held. The company also alluded towards taking MUN tokens out of circulation in the future by “burning” them after reacquiring them from advertisers who used the cryptocurrency to pay Munchee for ads on its app.
The SEC quickly stepped in on November 1st after determining that the structure surrounding the MUN tokens being offered in the ICO does, in fact, classify the token as a security. A closer look at the 1946 Supreme Court ruling in SEC v. Howey helps to explain this. In its ruling, the Court established the Howey Test to decide whether to label a transaction as a security. According to this test, to be qualified as an investment contract and thus a security a transaction must be judged by four factors: Whether 1. It is an investment of money; 2. There is an expectation of profits from the investment; 3. The investment of money is in a common enterprise; and 4. Any profit comes from the efforts of a promoter or third party.
The SEC came to its conclusion in a manner that parallels the Howey Test. The Commission determined that Munchee advertised and sold its tokens to investors, who paid Ether or Bitcoin in exchange for MUN (investment contract). According to the SEC, purchasers also had a reason to believe that MUN would earn them profits due to the token’s intended ecosystem model outlined above (expectation of profits from the investment). The SEC also found that these profits would be accomplished through the efforts of Munchee and its agents, for the most part excluding any third party.
Here we have tokens that provided no equity interest in the issuer and that nominally offered utility (albeit on a then-incomplete system), and yet the fact that investors reasonably expected their tokens to appreciate thanks to efforts by the issuer was enough to get the tokens deemed securities. There has been much speculation up until this point about whether the SEC would take this step, but now we know for sure.
By issuing MUN tokens without providing a registration statement or securing an exemption, Munchee had, according to the SEC, violated sections 5(a) and 5(c) of the Securities Act of 1933. Munchee immediately complied with the SEC’s ruling to cease and desist. No tokens were distributed and Munchee refunded investors who purchased any before the shut-down. The company has neither confirmed nor denied the SEC’s findings and has not yet released a public statement on the matter.
Article by Julianne Dardanes