I recently read an article citing a study that concluded that as many as 81% of initial coin offerings (ICOs) are scams. Several people contested that number but it cannot be too far off. If you have more than a cursory interest in crypto currency and ICOs it is hard to miss all of the discussion about ICO scams and what to do about them.
There is a general consensus among many in the ICO community that the ICOs need to stop kidding themselves that they are not securities and begin to seriously comply with US securities laws. In crypto industry parlance, there is an expectation that ICOs have begun to evolve into STOs (securities token offerings).
A company issuing a securities token will need to register the offering with the SEC or seek an exemption from registration such as Regulation D. Most STOs will be sold under Reg. D,in part because the SEC has yet to approve a registered offering and does not seem to be in any hurry to do so. US securities laws require that investors be given full disclosure of the facts that they need to make an intelligent decision whether or not to invest.
Around the same time, I came across a discussion on LinkedIn about an ICO for a company called BrightCOIN. The company is raising between $1 and $40 million to expand its tech platform which enables companies to launch their ICO in a “legally compliant” manner.
I read the white paper which is anything but legally complaint and I said so on LinkedIn. This got some brush back by the company’s CEO who commented, among other things that the company had a great lawyer who had helped prepare the white paper. The CEO claims to be a Y Combinator alumnus with several successful start-ups under his belt. So, of course, he should have an excellent lawyer.
I offered to explain why I thought that lawyer needed to go back to law school and the CEO scheduled two appointments with me so the lawyer could tell me that he was right and I was wrong. They cancelled both appointments at the last minute.
The ICO for BrightCOIN is intended to be a Reg. D offering. I would have thought that since it was selling a service and a platform where other companies can make “legally compliant” offerings, BrightCOIN would have taken pains to make its own offering “legally complaint”. They missed by a mile.
The BrightCOIN offering document is in what is now being called a “white paper format”. If you look at a lot of ICOs, a great many use this format. I do not know where it originated, but it does not generally make the disclosures that are required for a Reg. D offering in the format that the SEC expects. Using this format is an invitation to the SEC, state regulators and class action lawyers to come after you.
A Reg.D offering is also called a private placement and the offering document is called a private placement memorandum (PPM). There is a reason that most PPMs look alike. Back in the 1980s and 1990s regulators in several states required hands on review of every offering. I personally spent hours on the phone with the staff at these various state agencies going over specific language in Reg. D offerings. They usually wanted additional disclaimers; more risk disclosures; the words “this is a speculative investment” in the cover page in bold.
Congress eventually took away the states’ ability to comment on these offerings; but a lot of lawyers, including me, appreciate that much of what they wanted amounted to good practice. Disclosures are made for the benefit of the company that is raising the money. They are a prophylactic against legal action claiming fraud and misrepresentation.
BrightCOIN calls itself the Kickstarter for ICOs. It is essentially a crowdfunding platform for ICOs including those private placements offered under Reg. D and registered offerings filed under Reg. A+. BrightCOIN charges no upfront fees and will provide everything that a company needs to prepare and launch an ICO including “audited documentation”.
Of course Kickstarter does not handle any securities offerings. They operate in the world of “rewards based crowdfunding”, not securities crowdfunding, so the comparison to Kickstarter that BrightCOIN makes in its ICO white paper is meaningless.
Elsewhere BrightCOIN claims that it will become the “next Goldman Sachs” and compares itself to Goldman, Merrill Lynch and JP Morgan. The white paper included the logos for those companies, all of which I suspect are trademarked.
Did Merrill Lynch give permission for its trademark to be used in this offering? Does Goldman Sachs even know that BrightCOIN exists? Is there any way to read this hyperbole and not consider it to be misleading?
BrightCOIN claims that its tech platform is valuable because an entrepreneur considering launching their own Reg. A+ or Reg. D offering in the form of a token might spend as much as $500,000 to have the tech built. By “tech” it appears to be speaking about the crowdfunding platform that they are offering.
The last time I saw a bid to build a crowdfunding platform from scratch (November 2017) the cost was $50,000 and that had some unique CRM capabilities built in. I made a few calls and to add a token capability to that would cost no more than another $50,000 and probably a lot less. Where BrightCOIN gets that $500,000 number is anyone’s guess.
In any event there is no reason to create the crowdfunding technology from scratch. If you want to open your own crowdfunding platform there are several companies that offer white label products for a small upfront fee and even smaller monthly charge. At least one that I know of comes with AML/KYC capability attached.
For any offering of securities to be “compliant” it must present information in such a way that it is balanced to point that it is not misleading. The BrightCOIN white paper is full of interesting and unsubstantiated hyperbole.
Around the world, it appears that 10% of the funds that have been invested in ICOs have been hacked. BrightCOIN claims its platform is “100% hack proof”. I have spoken with large, mainstream financial institutions that spend a lot of money making their platforms “hack-resistant” but I do not know a single attorney who would put the phrase “100% hack proof” in a securities offering document. The truth is no one knows if a platform is hack proof until it happens.
The white paper discusses how BrightCOIN can be used to “tokenize” assets like real estate making those assets more accessible to small investors who will be able to trade those tokens on a global basis. The white paper notes (in bold type) that there are over $200 trillion worth of assets that can be tokenized. In the context it is presented, that statement is akin to me saying that there are 1 million single women in California implying that I will always have a date on Saturday night.
BrightCOIN claims their platform is fully functional and that they are already in business. Do they disclose how many offerings they have done and how much money those offerings have raised? They do not. They also claim that they offer consulting services to help a company prepare and market its ICO. Do they identify the people who perform these services? No.
BrightCOIN estimates that it may be able to list and sell 20 ICOs per month and might be able to take in $6.5 million per month in “success fees” if it does. The lawyer who they claim prepared this offering and who was supposed to call me and explain it to me should have told them that unless the platform is a licensed broker/dealer “success fees” are forbidden. No where does the white paper suggest that BrightCOIN intends to become a licensed broker/dealer.
People always ask me how is it that I can spot these scams when other people cannot. In most cases, like here, they do not pass the simple “smell test”. The founder, in my opinion, should simply stop this offering until it is actually compliant. If not people at Y Combinator should pull him aside and ask that he stop using their name.
In my opinion, the attorney, if he actually wrote this offering, which I doubt, should go back to chasing ambulances. When you prepare an offering of securities, it is expected that people will call up and ask some questions as part of their due diligence investigation. Any attorney, who agrees to field those questions, cancels two phone calls and makes no attempt to reschedule them, should refund the client’s money.
The entire ICO market has been one con after another. Telling investors the truth is not that difficult but it seems to be the one thing that the ICOs just cannot seem to do.