In one of its highest profile enforcement actions to date, the Securities and Exchange Commission sued Kik Interactive today, claiming it illegally raised $100 million through an initial coin offering in 2017 without registering as a security.
According to the suit filed in the Southern District of Manhattan on June 4, the ICO was a “Hail Mary pass” attempt to save the failing online messaging service firm by reinventing it as an ecosystem on the Ethereum blockchain powered by Kin cryptocurrency. [Kin later added Stellar transaction support.]
In doing so, the SEC alleged, Kik deliberately and knowingly violated the Securities Act of 1933 by failing to register the sale as a security offering, despite raising $55 million from U.S.-based investors. The agency has asked for a permanent restraining order against Kik, disgorgement of profits with interest, and an unspecified fine.
In its filing the SEC highlighted that Kik’s executives knew the Kin ICO met the definition of a security offering under the Supreme Court’s four-part Howey Test. That defines an investment contract as a security if buyers invest money in a common enterprise with the expectation of profit by the seller and buyer. In addition, a fourth requirement must be met—that expectation of profit must be based on future efforts of the promoter or a third party
The SEC noted that its DAO Report about the Howey Test came out seven weeks before the ICO, and that Kik banned Canadian investors after discussions with the Ontario Securities Commission. The SEC also quoted a Kik consultant’s “warning that a Kin offering that raised ‘millions’ and ‘was highly marketed to users and the public at large . . . risk[ed] becoming a security in the eyes of the SEC very quickly.’”
But in demonstrating that Kik’s ICO was a security offering, the agency heavily emphasized that at the time of the September 2017 ICO, the Kin ecosystem was vaporware. This requirement of future effort puts it squarely in the fourth prong of the Howey Test.
The SEC alleged in a release that Kik, “marketed the Kin tokens as an investment opportunity … told investors that rising demand would drive up the value of Kin, and that Kik would undertake crucial work to spur that demand, including by incorporating the tokens into its messaging app, creating a new Kin transaction service, and building a system to reward other companies that adopt Kin.”
At the time of the ICO, “these services and systems did not exist and there was nothing to purchase using Kin,” the SEC added.
What the SEC doesn’t say is that Kik now has other uses and many users. In a May 28, 2019 blog post expressing his frustration that the SEC’s view that nearly all cryptocurrencies are securities, Union Square Ventures partner and Kik board member Fred Wilson, pointed to the SEC’s investigation of the company.
“Kin is a digital currency (not a security) that is in use in over 40 mobile apps now,” Wilson wrote. “Last month over 1 [million] users earned Kin in one of those mobile apps and over 300,000 users spent Kin in one of those mobile apps. Kin is one of the most used crypto currencies in the world.”
The agency’s “unwillingness to come up with new rules paired with their ‘regulate by enforcement’ strategy is hurting the crypto sector, pushing it offshore, and is causing most of the new projects to raise capital outside of the U.S.,” Wilson added.
As a result, Wilson said, Kin was launching “DefendCrypto.org which is a crowdfunding effort to fight the SEC in court. Kin has contributed $5 [million] worth of BTC, ETH, and Kin to the effort.”
Which is not to say that Kin was a good investment. According to CoinMarketCap, the return on investment on Kin purchased at the ICO was -76.79% as of June 4.