December 13, 2017

SEC Issues Cease and Desist Order and Further Guidance on ICOs

On December 11, 2017, the U.S. Securities and Exchange Commission (SEC) issued a cease-and-desist order to Munchee Inc. (Munchee), a company that was in the process of a $15 million initial coin offering (ICO), for selling unlicensed securities. The SEC found that the ICO targeted investors, with the expectation of future profits, rather than users of the company’s products, with the explicit aim of using the token sale proceeds to further develop its iPhone application and corresponding “ecosystem.”[1] Munchee, upon being contacted by the SEC, stopped the sale and returned all ICO proceeds.

Immediately following the publication of the Munchee Order, SEC Chairman Jay Clayton released a public statement on cryptocurrencies and ICOs, reiterating the SEC’s focus on substance over form in evaluating the implications of the federal securities laws on ICOs.[2] Chairman Clayton specifically cautioned against assuming that any particular token will be considered a utility. Chairman Clayton’s comments suggest that the SEC may consider a true utility token to be an exception to the rule, which warrants caution and forethought when proceeding with any unregistered token sale. These developments represent the latest guidance from the SEC, as it endeavors to further define the bounds of regulation in the burgeoning ICO market.

The Munchee App and the MUN Token

Munchee is a California-based company that created an app (the “Munchee App” or “App”), which allowed individuals to post photographs and reviews of restaurant meals. The company began developing the App in late 2015, and launched the App in mid-2017 in the United States, the only country where it is currently available. By fall 2017, Munchee desired to improve its App by offering additional features, planning to execute its business plan and raise capital through the creation of a digital token, MUN, which would be incorporated into the App.  Munchee envisioned an expanded “ecosystem” where users would create new reviews in exchange for MUN or use MUN to buy meals and attain higher status within the Munchee App, with participating restaurants likewise obtaining MUN to reward diners and pay Munchee for advertising. The company set milestones for the Munchee App expansion through 2018 and 2019. Development and marketing of Munchee App and MUN was exclusively limited to the efforts of Munchee’s employees and agents, and the token was not designed to be functional for users on the App by the close of the ICO.

Munchee targeted its ICO marketing to the crypto community generally—i.e., people with an interest in tokens or other digital assets that have in recent years created profits for early investors in ICOs—rather than diners, restaurants, or other potential users of the platform. Munchee advertised that the company would continue developing and marketing the App, and that this would help increase MUN’s value. Munchee also touted the “burning” of tokens upon use on the App as a way to take tokens out of circulation and increase MUN’s potential profitability. The company further represented in its marketing materials that MUN could be traded on secondary exchanges within 30 days of the ICO’s closing. Its marketing was widespread and international in scope, utilizing social media and other platforms and featuring offering materials in different languages.

In October and November of 2017, Munchee offered and sold its digital token with the hope of raising approximately $15 million. On the second day of sales of MUN tokens, the company was contacted by the SEC. Munchee determined within hours to shut down its offering. As a result, it did not deliver any tokens to purchasers, and returned to purchasers the proceeds that it had received. 

The SEC’s Findings

As explained in the Munchee Order, the SEC determined that MUN tokens were securities under federal securities laws, and that its token sale amounted to an offering and selling of securities without filing a registration statement with the SEC or qualifying for a registration exemption. In examining the economic realities of Munchee’s token sale, significant to the SEC’s findings that the MUN tokens constituted securities were the following key facts:

  • The company primed purchasers to reasonably expect profits by (1) describing the way in which MUN tokens would increase in value as a result of Munchee’s efforts in developing and promoting the App and (2) retaining the right to “burn” tokens to increase the tokens’ value.
  • Investors relied on Munchee and its expertise in managing and developing the App and creating demand for MUN tokens.
  • The company represented that MUN tokens would be tradable on exchanges.
  • The company marketed its ICO internationally even though the App could only be used in the U.S.
  • The company marketed MUN tokens to investors in cryptocurrency generally, rather than purchasers who would actually use the App.
  • The token would not have any actual utility or value to users of the App by the close of the token sale because the platform would not be operational at that time.
  • The company planned to use proceeds from the token sale to further develop the “ecosystem” and integrate the MUN tokens into the Munchee App.

Though the SEC determined that Munchee violated federal securities laws, the SEC decided not to impose a civil penalty, noting Munchee’s prompt remedial measures and cooperation with the SEC.

Practical Implications

Based upon the SEC’s guidance in the Munchee Order and Chairman Clayton’s subsequent public statement, we offer the following practical considerations for any company considering engaging in a token sale, in order to mitigate the risk of liability under federal securities laws:

Structural Considerations:

  • Companies Must Have a Functional Platform Where the Token Can Be Used by the Time of the Token Sale.
  • The SEC Will Continue to Assess Substance Over Form, focusing on the “economic realities underlying a transaction,” rather than how the sale is described or how the token is labeled or named.
  • Improvements and Value Added to the Platform Should be User-Driven. The SEC’s guidance in Munchee suggests that it will examine the economic realities to determine where the true value for the token is being derived from, rather than simply considering the stated incremental value that a user may contribute. For example, while Munchee’s business plan contemplated that the token users would eventually “buy advertisements, write reviews, sell food, and conduct other transactions” on the Munchee platform, in reality, the SEC noted that the majority of the near-term value of the platform was “derived from the significant entrepreneurial and managerial efforts of others – specifically Munchee and its agents.” This factor also weighed in favor of the MUN token as an investment contract, where token purchasers were seeking to derive profits based upon the efforts of Munchee’s personnel, whose credentials, abilities and management skills were highlighted in the promotional materials. The SEC also found it significant that no other person (besides Munchee employees) could make changes to the Munchee App or work on the ecosystem to create a demand for MUN tokens at the time of the offering and sale.
  • The Tokens Should Not Be Made Available on an Exchange, or Otherwise Marketed as Being Available in the Secondary Market. Chairman Clayton also cautioned against companies creating offering systems and platforms that facilitate the transfer of tokens, as such platforms have potential implications of operating as unregistered exchanges or broker-dealers in violation of the federal securities laws.
  • Burning Tokens May Be Viewed as Intentionally Increasing Scarcity to Drive Value.

Promotional/Marketing Considerations:

  • Do Not Promote the Likelihood of the Token Increasing in Value.
  • Marketing Should Be Accurate, Not Investment Focused, and the Company Should Monitor All Marketing Outlets, including BitcoinTalk, blogs, message boards, Twitter, Facebook and YouTube.
  • Limit Marketing Efforts to Existing Users or Those in the Industry of Use.
  • Limit Marketing Efforts to Users Who Could Actually Access the Platform.
  • Consider Not Selling to Purchasers in the United States. In the case of Munchee, the SEC’s guidance came in the context of a token offering that was sold to U.S. investors, anticipated being eligible for sale on a U.S.-based exchange, and was of purported utility that existed only on a U.S.-based iPhone application.

Over the past several months, scores of clients from around the world have relied on Goodwin to execute their initial coin offerings, drawing from our expertise in regulatory compliance and enforcement, tax, and blockchain and emerging technology startups. Our experienced attorneys can guide you through the full lifecycle process of a token sale with a core team that includes experienced former U.S. federal prosecutors, corporate securities lawyers, specialists in financial transaction regulations and OFAC issues, and former in-house counsel for a regulated options exchange. Goodwin’s technical expertise, geographic footprint in key industry markets, and depth of experience allows us to offer unprecedented service to help our clients capitalize on opportunities and meet the challenges of this evolving industry.

[1] Munchee Inc., Securities Act of 1933 Release No. 10445 (“Munchee Order”) (December 11, 2017), (order instituting cease-and-desist proceedings pursuant to Section 8A of the Securities Act of 1933, making findings, and imposing a case-and-desist order). 

[2] SEC Chairman Jay Clayton, Statement on Cryptocurrencies and Initial Coin Offerings, U.S. Securities and Exchange Commission (Dec. 11, 2017),