John Reed Stark

As many readers undoubtedly are aware, the prices for bitcoin has plunged in recent days, from a peak of nearly $20,000 in December to approximately $8,300 more recently, representing a decline of nearly 60%. The prices for other cryptocurrencies have also fallen along the same order of magnitude. This dramatic decline certainly at least raises the question of whether or not the pricing bubble for cryptocurrencies that fueled the recent wave of initial coin offerings (ICOs) has burst – or at least, is about to burst. In the following guest post, John Reed Stark, President of John Reed Stark Consulting and former Chief of the SEC’s Office of Internet Enforcement, suggests that the bursting of the ICO bubble may be exactly what the financial marketplace needs for the long haul. I would like to thank John for his willingness to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest for this site’s readers. Please contact me directly if you would like to submit a guest post. Here is John’s guest post.


 “I believe every ICO I have ever seen is a security . . . ICOs should be regulated like securities offerings. End of Story.” — SEC Chairman Jay Clayton

The above is just a sample of the many blunt and serious warnings SEC Chairman Jay Clayton stated while testifying before the Senate Banking, Housing and Urban Affairs Committee on February 6, 2018, during a hearing to discuss virtual currencies.

Initial Coin Offerings (“ICOs”) — the trending method of capital formation by which startups or other parties can issue cryptographic tokens in an effort to fund or bootstrap a new blockchain network – are in trouble. The ICO bubble could burst any minute, which may destroy the wealth of some, but will also better secure the financial future of all.

As the former Chief of U.S. Securities and Exchange Commission’s (SEC) Office of Internet Enforcement, my take is that in the coming year or two, the SEC, the U.S. Financial Crimes Enforcement Network (FinCEN), the U.S. Department of Justice (DOJ), the Commodity Futures Trading Commission (CFTC) and a slew of other federal and state agencies will initiate a continuing sweep of ICO-related enforcement actions, triggering a virtual earthquake in the ICO industry.

But amid the fallout of Chairman Clayton’s ICO blitzkrieg, there will also be a faint, yet gleaming ray of sunlight. An ICO bubble burst will inevitably insure that whatever cryptocurrency marketplace survives will provide the same customer protections and capital safeguards often taken for granted in the context of the traditional trading of securities. This not only makes for good business but for a more robust and resilient global financial marketplace as well.

First of all, by cutting out unlawful conduct in the blockchain space, Chairman Clayton is clearing the way for a revolutionary transformation of all things fintech. As Senator Mike Crapo, Chairman of the Senate Banking Committee, stated in his opening remarks of the February 6th hearing:

“Much of the recent news about virtual currencies has been negative; between the enforcement actions brought by your agencies, the hack of the international Coincheck exchange, and the concerns raised by various regulators and market participants, there is no shortage of examples that increase investor concerns. It is also important to note that the technology, innovation and ideas underlying these markets present significant positive potential. These aspects underpinning virtual currencies have the ability to transform for investors the composition of, and ability to access, the financial landscape, thus changing and modernizing capital formation and transfer of risk.”

Secondly, by cleaning up the ICO marketplace, Chairman Clayton and the SEC are also helping to combat the increasingly disturbing and dark side of cryptocurrency growth. While the unfettered and shadowy nature of ICOs remains unsettling to say the least, what is most frightening is that ICOs help facilitate the criminal side of the cryptocurrency world.

Given their anonymous nature, cryptocurrencies have evolved into the payment mechanism of choice for unlawful transactions – from buying a fake I.D. or a bottle of opiates, to receiving a cache of credit card numbers or stolen identities, to collecting a ransomware payment demand or even for funding terrorist-related activities.  Slowing the growth of this unlawful behavior is a notion that appeals not just to market participants, but also to the myriad of victims of crypto-funded ransomware, terrorism, drug dealing and the like.

Chairman Clayton and Senator Elizabeth Warren: Two Peas in a Pod?

Chairman Clayton will not stand alone in his fight against ICOs. In addition to sitting alongside CFTC Chairman J. Christopher Giancarlo during the hearing, who echoed Chairman Clayton’s concerns, sitting opposite Chairman Clayton, singing the same chorus, was none other than Senator Elizabeth Warren.

Yes, that Senator Warren, the one who opposed Chairman Clayton’s nomination and who pretty much combats most everything any Republican in Washington, D.C. has ever wanted to do.

Senator Warren sits on the Senate Banking Committee and the love-fest between the two during the hearing was as remarkable as it was uncomfortable. Witness this awkward exchange:

Senator Warren: “In 2017, companies raised more than $4 billion in ICOs. How many of those ICOs registered with the SEC?”

Chairman Clayton: “Not one.”

Senator Warren: “As of today, how many companies have registered for upcoming ICOs?”

Chairman Clayton: “Not one.”

Senator Warren: Why?

Chairman Clayton: “I don’t think the gatekeepers that we rely on to assist us to ensure our securities laws are followed have done their job. We’ve made it clear what the law is. As I’ve said many times, there are thousands and thousands of private placements that go on every year in the U.S. We want them to go on. We want people to raise capital, but we want them to do it right . . . What ICOs do is they take the disclosure-like benefits of a private placement and then add to it the public general solicitation and retail investor promise of a secondary market without registering with us. And folks somehow got comfortable that this was new and it was OK and it was not a security and just some other way to raise money. Well, I disagree.”

Senator Warren: “So it is new, but it’s not OK, and it’s not another way to raise money?’

Chairman Clayton: “Correct.”

Recognizing the old adage of “the enemy of my enemy is my friend,” the two uneasily share common ground — and Senator Warren concluded her questioning with a wry smile, complimenting Chairman Clayton and wishing him luck with his ICO offensive.

Senator Warren’s position is actually not at all surprising. She is a fierce consumer advocate and ICOs represent a significant threat to consumers and every day main street investors. Indeed, the liberal Massachusetts Senator has previously held a critical stance on the blockchain funding model — notable in part because her home state’s government has filed suit against ICO organizers in the past.

Her concerns stem not just because of the threat of ICOs to everyday investors but also because of their brazen flouting of U.S. securities regulations. ICOs have grown largely outside of regulatory oversight and without the investor protections and disclosure requirements that apply to traditional investment offerings. In fact, ICOs provide a virtual “Driver’s Edfilm of possible securities law violations.

The panoply of illegalities associated with ICOs could fill its own legal treatise, including the unlawful: 1) offer, sale and promotion of securities; 2) operation of a stock exchange; 3) sale of an unregistered mutual fund; 4) failure to meet anti-money laundering laws; 4) sale, advertising and promotion of commodities; and the list goes on.

Thus, aside from just about every U.S. federal regulator, including the U.S. Treasury Department, the Financial Crimes Enforcement Network and the CFTC, the SEC Chairman can also count among his allies not just his fellow Republicans on the Hill, but also Senator Elizabeth Warren, perhaps the most ferocious of today’s anti-Trump and anti-Republican Democrats. Powerful bedfellows indeed, the dynamic duo is a force not to be taken lightly by ICO promoters and advocates.

Chairman Clayton will undoubtedly need all of the help he can get with his ICO offensive. ICO growth has been nothing short of astonishing. Before 2017, ICOs had raised a total of about $300 million going back to 2014. Fast forward to 2017, where according to Coindesk, the ICO market raised over $3.7 billion, in 235 ICOs, including over $800 million in ICOs during the month of September 2017 alone.  And there is no sign of any slowdown – one recent report claims that with around 68 successfully conducted ICOs raising roughly $1.3B in January, the ICO market saw a slight decline from its all-time-high in December 2017 (74 ICOs / $1.6b raised).

Chairman Clayton and ICOs

Chairman Clayton’s recent Congressional testimony was not the first time the SEC has broadcast its drumbeat regarding ICOs (which Chairman Clayton sees as IPOs masquerading as ICOs). In fact, Chairman Clayton’s voice in particular has been especially loud and pervasive with respect to his concerns about ICOs, utilizing a broad range of the SEC’s formal and informal distribution channels to communicate his concerns.

For instance, Speaking on November 9th, 2017, Chairman Clayton warned that ICOs in many cases looked like securities and were susceptible to fraud and chicanery by ICO insiders, management and better-informed traders and market participants.

Veering off-script, Chairman Clayton reportedly stated bluntly:

“I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security . . . there is also a distinct lack of information about many online platforms that list and trade virtual coins or tokens offered and sold in ICOs.”

Along these lines, the SEC has issued a slew of unprecedented official statements about ICOs including a detailed Investor Bulletin warning investors about ICOs and a Report of Investigation pursuant to Section 21(a) of the Securities Exchange Act of 1934, explaining how ICOs are unlawful.

The SEC even went so far as to put the spotlight on social media ICO promotions and endorsements by celebrities that were not properly disclosing the celebrity’s financial relationship to the ICOs. The SEC warning admonished celebrities and other influencers that they may run afoul of securities laws when advertising cryptocurrency and other investments including ICOs.

Few ICO market participants will likely escape the SEC’s dragnet – as well as the reach of state regulators, and the litany of other federal regulatory and criminal prosecutorial agencies who will surely (and eagerly) follow the SEC’s lead.

What will result in the short-run won’t be pretty – there will be some blood on the floor in the form of lost investments from honest wide-eyed investors caught up by the current ICO whirlwind.  But what will follow in the long-run (if possible) will be a more fulsome, more transparent, more reliable, more efficient and far healthier cryptocurrency/blockchain marketplace.

The First Domino to Fall: Facebook Bans ICO Advertising and More. 

Some companies have already begun to heed Chairman Clayton’s warning. Facebook, on January 30, 2018, announced that it is banning all cryptocurrency advertising, including ICOs, Bitcoin And Ethereum. The social media giant will no longer permit advertising promoting “financial products and services that are frequently associated with misleading or deceptive promotional practices, such as binary options, initial coin offerings, or cryptocurrency.”

Facebook Product Management Director Rob Leathern explained that Facebook’s ban is not intended to reflect Facebook’s stance on the cryptocurrencies, but rather to remove the possibility of scams and bad-faith actors using the platform to manipulate users:

“We want people to continue to discover and learn about new products and services through Facebook ads without fear of scams or deception. That said, there are many companies who are advertising binary options, ICOs and cryptocurrencies that are not currently operating in good faith.”

The Aftermath of the ICO Bubble Burst

Chairman Clayton’s ICO bubble burst will insure that whatever cryptocurrency marketplace survives will provide the same customer protection’s and capital safeguards often taken for granted in the context of the traditional trading of securities. This not only makes for good business, but for a more robust and resilient marketplace as well.

Bear this in mind: In U.S. capital markets, when an investor orders 100 shares of his or her favorite stock, a transparent and meticulously recorded transaction occurs. That’s because — and this is no coincidence — U.S. markets in addition to being the most heavily regulated are also the most efficient, most robust and most secure in the world. ICOs turns this traditional notion of safety and confidence on its head – which is troubling.

While the U.S. government should not discourage modernization or technological advances like the many possible benefits and applications of blockchain technology, the SEC and other government agencies should ferret out the abuses while offering assistance and guidance to the pioneers of securities markets.

Although innovation and creativity have made U.S. securities markets the best capital formation system in the world, careful and thoughtful government intervention has ensured that U.S. markets also have the highest level of integrity and safety.

As SEC Chairman Clayton and CFTC Chairman Giancarlo stated in their January 25th WSJ op-ed article on cryptocurrencies and ICOs:

“The willingness to pursue the commercialization of innovation is one of America’s great strengths. Together Americans embrace new technology and contribute resources to developing it. Through great human effort and competition, strong companies emerge. . . . Distributed ledger technology may in fact be the next great disruptive and productivity-enhancing economic development. If history is any guide, DLT is likely to be followed by many more life-changing innovations. But we will not allow it or any other advancement to disrupt our commitment to fair and sound markets.”

After the dust settles from the SEC ICO onslaught, what will result in the short-run admittedly won’t be pretty – there will be some blood on the floor in the form of lost investments from honest wide-eyed investors caught up in the current ICO whirlwind. Even the so-called ICO “gatekeepers,” such as the lawyers who have helped facilitate unlawful ICO offerings and promotions, will perhaps take a hit.

But what will follow in the long-run (if possible) will be a more fulsome, more transparent, more reliable, more efficient and far healthier cryptocurrency/blockchain marketplace. Not a bad result for Main Street and Wall Street investors — and a noble SEC enforcement quest that cannot be denied.


John Reed Stark is president of John Reed Stark Consulting LLC, a data breach response and digital compliance firm. Formerly, Mr. Stark served for almost 20 years in the Enforcement Division of the U.S. Securities and Exchange Commission, the last 11 of which as Chief of its Office of Internet Enforcement. He currently works as an adjunct professor at the Duke University Law School Winter Session and also worked for 15 years as an Adjunct Professor of Law at the Georgetown University Law Center, where he taught several courses on the juxtaposition of law, technology and crime, and for five years as managing director of a global data breach response firm, including three years heading its Washington, D.C. office. Mr. Stark is the author of, “The Cybersecurity Due Diligence Handbook.”