The legal status of cryptocurrency token airdrops under U.S. securities regulations remains a topic of great interest. Many issuers wonder if they might use airdrops to avoid scrutiny of their token under U.S. securities regulations. While the definitive answer remains unsettled, a recent order from the SEC suggests it may (rightly or wrongly) treat airdrops as securities.
Background of the Securities Laws as Applied to Cryptocurrency
Section Five of the Securities Act of 1933 prohibits the offer or sale of securities unless the issuer has registered the offering with the SEC, unless the offer and sale qualifies for one of several exemptions (all of which themselves contain various requirements). The SEC has made clear that it considers nearly all cryptocurrencies in circulation today to constitute securities under the Howey test for investment contract securities and thus subject to the requirement of registration or exemption. The legal and regulatory scheme that Congress and the SEC have promulgated detailing the specific requirements of registration and exemption are lengthy and complex (for example, mere advertising of a foreign sale may trigger application of the U.S. securities laws), and issuers naturally seek to minimize the burden of compliance.
One potential strategy many issuers have proposed would be to issue tokens via airdrop, reasonably defined as a distribution of tokens by an issuer to blockchain addresses of random or targeted individuals without charge and in some cases without solicitation. The question that naturally arises is whether airdrops or related distributions constitute offers or sales of securities and thus whether issuers might deploy airdrops to avoid compliance with SEC regulations. While the definitive answer remains unsettled, a recent order from the SEC may provide guidance.
In re Tomahawk Exploration LLC, et al.
According to a recently issued consent order, between July and September 2017 an oil and gas exploration company called Tomahawk Exploration LLC issued a number of tokens called “Tomahawkcoins” through an online ICO. Tomahawk issued some of these coins as part of a “bounty program” to recipients who did not pay for them with fiat or cryptocurrency but instead agreed to provide various online promotional and marketing services, including making requests to list the token on various trading platforms, promoting the token on blogs and other online forums, and creating professional picture file designs, YouTube videos, and other promotional material. Tomahawk did not register the offer and sale with the SEC, nor did it fit within any exemption to the registration requirement.
The SEC instituted public administrative and cease-and-desist proceedings against Tomahawk for a variety of alleged securities law violations (including allegedly fraudulent statements made in conjunction with the offer and sale). Included in these was an allegation that the tokens distributed in Tomahawk’s bounty program qualified as investment contract securities under the Howey test because they constituted an investment of money “or other contributions of value” in a common enterprise with a reasonable expectation of profits, to be derived from the oil exploration and production operations conducted by Tomahawk. Also included was an allegation that the bounty program qualified as an offer and sale of securities because it involved a distribution “for value”. The SEC order cited to a 2009 Ohio case, SEC v. Sierra Brokerage Servs., Inc., 608 F. Supp. 2d 923, 940-943 (S.D. Ohio 2009), aff’d, 712 F.3d 321 (6th Cir. 2013), for the proposition that a “gift” of a security is actually a “sale” within the meaning of the Securities Act if the “donor” (here Tomahawk) actually received a benefit. The SEC charged that Tomahawk here received value or benefit in exchange for the bounty distributions not only in the form of online marketing and promotion but also “in the creation of a public trading market for its securities.”
Ultimately, Tomahawk entered into a consent order stipulating to violations of, among other laws, Section Five of the Securities Act, and its founder agreed to pay a civil penalty of $30,000.
What Tomahawk May Mean for Airdrop Issuers
In re Tomahawk strongly suggests that, rightly or wrongly, the SEC may consider airdrops to constitute offers or sales of securities under Section Five of the Securities Act. Even when airdrops land without charge and in some cases without any required action by the recipient, the SEC suggested in Tomahawk that the issuer’s enjoyment of a resulting market for the token might suffice as value received for the token. The classification of airdrops as securities becomes even more likely when considering that the SEC has expressed repeated concern for cryptocurrency and token investors generally and reiterated its role in protecting these investors. This is not to say that the SEC has expressed hostility towards cryptocurrency or tokens generally. But the SEC continues to indicate that it will cast its jurisdiction broadly and attempt to require a wide variety of token issuers to comply with the registration or exemption requirements.