Let's Talk Zaslavskiy: A Preliminary Ruling on whether a token sale is a security.
Zaslavskiy ( U.S. V. Zaslavskiy, 17-cr-0647 ) is a recent court case where the court asked, and answered, the question of whether an ICO could be deemed as an offering of securities. Zaslavskiy's importance is not the ruling itself, as it is a preliminary ruling, but how the court analyzed and reached the conclusion that ICOs may be a security offering.
I'll first explain that this is a preliminary ruling, in a motion to dismiss. In general, it is not the final ruling. A motion to dismiss is a request submitted by the defendant that states, that even if all the facts alleged against him in the indictment are true, then the court won't be able to find him guilty; meaning, that the facts alleged against him do not constitute as a crime.
Here, Zaslavskiy claimed that his ICO did not fill the Howey test; The court failed to agree. But first, let's understand what Zaslavskiy's business was: Zaslavskiy's first ICO was called "REcoin"; this was supposed to be the first cryptocurrency backed up by real estate. According to their press release, "REcoin is a new proprietary cryptocurrency designed for a broad range of financial transactions and backed by the real estate held by the 101REcoin Trust, which includes the real estate in developed and stable economies like the USA, Canada, Japan, Great Britain and Switzerland". Of course, this was not the case, and REcoin did not have any real estate.
Then, when the ICO succeeded, but the plan failed, Zaslavskiy approached his investors and offered them to convert their investment into the Diamond Reserve Club. Here, "The Diamond Reserve Coin (DRC) is hedged by physical diamonds stored in secure locations in the United States and fully insured for their full value. Each owner of an electronic wallet holding at least 1 DRC is a member of the Diamond Reserve Club and has rights, privileges and is entitled to benefits according to his or her membership level – the more tokens, the higher the membership level".
In both cases, the court finds that the Howey test applies and that these are "investment agreements" at least by the alleged facts. Why? well, that's dead simple.
While a lot of public pre-sales prior to ICOs offer "accredited investors" the option to invest in their pre-sale, here this even didn't happen. Zaslavskiy's ICO hold all the pillars of Howey: it is a public offer, first and foremost. Zaslavskiy operated a website that allowed people to participate in the crowd sale.
Now, let's talk about the tokens themselves. Are they considered securities? well, why not? First, the court finds that there was an investment of money ("Investors in Zaslavskiy's schemes were "able to invest in REcoin [and Diamond] through [their] websites using their credit cards, virtual currency or online funds transfer services."). Then, the court finds that a common enterprise existed; meaning, that each token by itself was identical to the other, and that when one member's token's value went up, the others did, as well. Third, the court finds that the profits were derived solely from Zaslavskiy's and his team's efforts and not the token holders.
How is this important for future ICOs? Well, the most important thing here is to learn that not all tokens that represent physical presence are specifically "utility tokens" and even if diamonds by themselves are not securities, then tokens that derive their value from diamonds are.
Next, your ICO should be planned in a way that dumps the "common enterprise" method. If each token has an inherently different value then the other tokens, and if they are not fungible, then you might be in a safer place. What does that mean? that if Zaslavskiy's tokens would have represented works of art instead of diamonds or whether each token would have been a specific part of a specific real estate property, whose values goes up and down regardless of the other properties, then it might have had easier lives.
If you're planning on doing an ICO, consult legal experts; also, understand that merely preparing paperwork and approaching accredited investors might not be enough. While this is a trend in the global ICO economy nowadays, we are quite close to the day where the SEC will decide that a SAFT, by itself, is not enough to be out of the "security" playfield.
You can also read my ICO handbook and learn more.
Chapter One: Other People's Money, an Introduction.
Chapter Two: Scams, or why do we need investor protection?
Chapter Three: The Investors, or who doesn't need protection.
Chapter Four: What is a security, or: the Howey test, simplified.
Chapter Five: Avoiding the Howey Test.
Chapter Six: Airdrops.
Chapter Seven: Valueless Tokens.
Chapter Eight: Token Burns; another way to avoid Howey.
Chapter Nine: Limited Supply Does Not Mean Increase In Value.
Chapter Ten: Approaching Investors, the legal framework