SEC Action Against Tomahawk and Laurance: A Cautionary Tale
The U.S. Securities & Exchange Commission recently issued a cease-and-desist order in the matter In re: Tomahawk Exploration LLC & David Laurance that has attracted understandable attention from ICO watchers and participants. In Tomahawk, the company had intended to issue TOM tokens to finance oil wells in California, and even though it never consummated its ICO or raised any money through the sales of coins, nevertheless was sanctioned by the SEC for distributing tokens to participants in the company’s “bounty” scheme. In an administrative order, the SEC concluded that Tomahawk and Laurance had violated U.S. securities laws and levied a $30,000 fine against Laurance, also banning him from serving as an officer or director of any public issuer or participating in a penny stock offering.
The Tomahawk action has received considerable attention in the crypto space because bounty programs had been a popular method of promoting ICOs. Bounty programs traditionally worked by awarding digital tokens to participants who mentioned or discussed the upcoming ICOs on social media sites or elsewhere on the Internet, without further payment of cash or other cryptocurrencies. The free advertising was valuable to the company conducting the ICO, and the tokens were attractive enough that many people elected to participate.
It would be a mistake, however, to interpret Tomahawk as announcing a new principle of American securities law. Rather, the cease-and-desist letter serves as a reminder by the SEC of a long-existing principle from Section 2 of the Securities Act of 1933: “The term ‘sale’ or ‘sell’ shall include every contract of sale or disposition of a security or interest in a security, for value”. Notably, “for value” does not mean the same as “for money,” and agreements to issue securities for non-monetary goods or services, if of economic value to the issuer, are considered sales of securities under U.S. law and thus subject to the ’33 Act. The critical lesson from Tomahawk to those in the ICO space is that tokens distributed in a bounty program are subject to the same requirements that token purchases are—that is, if tokens are not to be sold to U.S. residents or to any but accredited investors, then they cannot be distributed as part of a bounty program, either. (Genuinely free distributions under so-called “airdrops” appear to fall outside the logic of the Tomahawk cease-and-desist and may still be permissible, but companies conducting an ICO should be careful that they do not derive any economic benefit in exchange for the airdrop.)
Many ICO watchers are nonetheless concerned that the Tomahawk action presents a cautionary precedent. Under close examination, however, there are reasons to be skeptical that Tomahawk is applicable to traditional ICOs. To begin, the procedural posture of the action limits its applicability to other cases; as part of the settlement of charges, the defendants had consented to the SEC’s findings of fact, for present purposes only and not as binding on other parties. Thus, the SEC was able to reach a clear factual determination in Tomahawk that it would have had to prove otherwise.
Most importantly, perhaps, the defendants in the Tomahawk were uniquely vulnerable targets to SEC action, which raises a question as to how much precedential weight the action would pose to other ICOs. Tomahawk proposed to issue digital tokens that were clearly a security, rather than a utility token. Utility tokens lack the characteristics of a security, and issuers who seek to comply with American securities law often structure their ICO according to the guidance in the Munchee letter. In contrast, Tomahawk tokens were explicitly security tokens; not only did Tomahawk represent that they would be backed by the revenue from oil wells that Laurance proposed to build with the ICO proceeds, but each token would be convertible into a share of common stock in Tomahawk, making them equivalent to stock options.
In addition to the failure to structure the ICO as a utility token, Tomahawk made several egregious moves that were likely to attract SEC enforcement. In promotional materials, the defendants had promised investors with guaranteed profits at no risk. Additionally, public statements about Tomahawk contained fraudulent misstatements of fact about the company’s prospects. The SEC found that Laurance’s statements as to the amount of available oil were inflated. And significantly, the Tomahawk whitepaper represented that the defendants had “made sure that our team and Board of Directors are refined successful citizens with flawless backgrounds”—a fraudulent misstatement, as Laurance had been convicted and jailed for securities fraud in connection with one company, overseen another company that resulted in other securities charges, and gone through multiple bankruptcies. (Although Laurance was convicted more than ten years prior, and the company did not appear to attempt to rely on Rule 506, and hence his status as a “bad actor” was not strictly relevant to the SEC’s decision, it is hard to avoid the suspicion that his personal history loomed large in the enforcement decision.)
Nevertheless, the Tomahawk action serves as a warning to participants in the ICO and cryptocurrency fields. Even if it is not a controlling interpretation of American securities law until a court agrees, Tomahawk is at least a statement of the view of the SEC, and companies considering a possible ICO would be well advised to take a lesson from the SEC action. (As one sign of how seriously the SEC took the case, the cease-and-desist acknowledged that Laurance had pled his own poverty as a reason to avoid a civil penalty—and then imposed the penalty anyway, additionally forbidding him from seeking to appeal the penalty or discharge it through bankruptcy.) Particularly, the Tomahawk action reiterates the importance of structuring an ICO in compliance with the securities laws of the U.S. and other jurisdictions in order to avoid potential liability.
David Tice, Foreign Legal Consultant