The U.S. Securities and Exchange Commission (SEC) has sued messaging app Kik over their 2017 ICO for its KIN token. Officials allege that the ICO constituted an unregistered securities offering. Steven Peikin, co-director of the SEC’s Division of Enforcement that Kik “deprived investors of information to which they were legally entitled, and prevented investors from making informed investment decisions.”
Kin raised approximately $100 million from over 10,000 investors in their token sale, with over half of the money coming from U.S. investors.
Kik vs SEC
According to the filing, Kik had been in a dire financial situation with its messaging app before deciding to pivot to a cryptocurrency project. Kik decided to sell “Kin” tokens to fund the new venture, characterizing it as a utility token in spite of the fact that none of the services it promised had been built yet.
The offering included steep discounts for wealthy investors, with Kik promising that increased demand for Kin would correlate with greater value. The lawsuit boils down to three allegations:
- Kik deprived investors of information they were entitled to
- Kik marketed Kin as an investment opportunity
- Kin is not a utility token
Kik was served with a “Wells Notice,” by the SEC in November of 2018 after reviewing the facts behind Kik’s ICO. In response, Kik issued their “Wells Response” in December, a 41-page document detailing Kik, their launch of the Kin token, and why they believe it does not represent a security.
Kik’s defense stated that Kin represents a currency rather than a stock and because Kin holders have no direct interest in how Kik performs as a company. This makes no sense, however, because the utility of Kin depends on the Kik app, then Kin holders have plenty to worry about if Kik goes bankrupt. The announcement of this lawsuit demonstrates the SEC’s lack of confidence in Kik’s response.
The demise of Kik?
Like Facebook and many other tech companies, Kik has plenty of experience dealing with regulators and law enforcement. Kik’s website includes a page of resources for law enforcement, providing a Guide for Law Enforcement, a page detailing their outreach efforts, and forms for emergency disclosure and preservation requests.
The company has framed the lawsuit as a battle for the future of cryptocurrency. Founders warn that if Kik loses their battle, the SEC will come after other firms using cryptocurrency. Winning this has become a battle of “David vs. Goliath” in which Kik has characterized itself as having no choice but to take on the SEC.
If it is determined that the 2017 ICO constituted a securities offering, then Kik did deprive investors of information by failing to register the offering. Combined with Kik’s other transgressions, it appears highly likely that Kin will be deemed a security.
In a video filmed at a San Francisco Bitcoin meetup in June 2017, Kik CEO Ted Livingston stated:
“You can become a stakeholder, you can share in the economic upside in the creation of this ecosystem.”
Under the current law, this explicitly violates the Howey Test for defining a security.
Whether Livingston misspoke or not, the statement puts Kik on record as marketing an investment opportunity. As far as being a utility token or not, Kin may be a utility token once the utility is built but as long as it’s used to raise funds for a utility, it counts as a security.
Cryptocurrency & the SEC
SEC Director of the Division of Corporate Finance William Hinman previously described Bitcoin and Ethereum transactions as “not securities transactions” at the Yahoo Finance All Market Summit: Crypto, however, he did include a critical and often overlooked caveat in “putting aside the fundraising that accompanied the creation of Ether.”
Issuing a token to raise funds before having a working product, even in a “decentralized” manner and including to pay for things like marketing efforts, can reasonably be considered a violation of the Howey Test.
In his own words, Hinman said:
“Even digital assets with utility that function solely as a means of exchange in a decentralized network could be packaged and sold as an investment strategy that can be a security.”
The outcome of Kik’s lawsuit could have dire repercussions for other U.S.-based blockchain startups that have relied on issuing “utility tokens.”