{"id":13647,"date":"2019-06-04T22:59:37","date_gmt":"2019-06-04T22:59:37","guid":{"rendered":"https:\/\/davidgerard.co.uk\/blockchain\/?p=13647"},"modified":"2019-06-05T16:41:57","modified_gmt":"2019-06-05T16:41:57","slug":"the-sec-finally-loses-patience-and-sues-kik-over-the-kin-ico","status":"publish","type":"post","link":"https:\/\/davidgerard.co.uk\/blockchain\/2019\/06\/04\/the-sec-finally-loses-patience-and-sues-kik-over-the-kin-ico\/","title":{"rendered":"The SEC finally loses patience \u2014 and sues Kik over the Kin ICO"},"content":{"rendered":"

Kik is an instant messaging service, targeting teenagers. It’s had a few rounds of venture capital \u2014 but, by 2017, its user numbers were declining,<\/a> and the money was running out.<\/p>\n

\"\"<\/a>So, in August 2017, they ran an ICO<\/a> \u2014 for a token called Kin, to run on the Ethereum blockchain.<\/p>\n

(Partly, anyway. The Kin white paper<\/a> describes a “centralized off-chain ledger” \u2014 i.e.,<\/em> a database. Their “general purpose cryptocurrency” that they hoped would take cryptocurrency “mainstream” was always meant to be completely centralised.)<\/p>\n

It was pretty obvious that what Kik was selling would constitute a security under US law, per the Howey test<\/a> \u2014 a simple and broad test that’s stood up in US law for nearly a century now.<\/p>\n

I thought at the time<\/a> that Kik wouldn’t be obvious candidates for legal action \u2014 but the SEC sure seems to. And today, the SEC sued Kik.<\/a><\/p>\n

The Kin offering<\/h3>\n

By early 2017, Kik was in trouble. User numbers were down, they couldn’t get any more venture capital \u2014 and they faced going broke by the end of the year. They even tried to sell the company, but nobody was interested.<\/p>\n

One board member came up with a “hail Mary pass” \u2014 start an ICO and sell tokens!<\/p>\n

The Kin ICO was announced on 25 May 2017. The sale ran through September 2017, and Kik raised a total of $99 million \u2014 $50 million in US dollars from wealthy investors, and $49 million in ether from the general public. They sold most of the ether for dollars straight away.<\/p>\n

In December 2017, CryptoKitties showed that Ethereum literally couldn’t scale up to cat pictures.<\/a> Kik decided to issue Kin on Stellar<\/a> instead \u2014 originally on the public Stellar blockchain, but eventually just a single-node private instance of Stellar.<\/p>\n

In January 2018, someone sent me a tip<\/a> that the Kin ICO had attracted adverse attention from the SEC. I got a draft press release<\/a> saying how SEC staff had been in touch with Kik in September 2017 in the final days of the Kin sale, that Kik was cooperating, and everything was fine<\/em> \u2014 but also, I got screenshots of internal messages about how Kik was trying to work out how to give back all the ether that had been used to buy tokens.<\/p>\n

I must stress that this was only from a single source \u2014 but it all seems to have checked out.<\/p>\n

Through 2018, Kin did as well in the markets<\/a> as every other substanceless 2017 ICO token \u2014 from its 6 January 2018 peak of 0.1 cent, to its 4 June 2019 price of 0.0028 cent, or a third of a satoshi if you’re counting in bitcoins.<\/p>\n

Discussions with the SEC didn’t go so well. Ted Livingston, Kik’s founder, says how<\/a> “our conversations slowly ramped up \u200a\u2014 \u200afirst with more questions, then with subpoenas over the winter, and then formal testimony in Washington over the summer.”<\/p>\n

On 16 November 2018, the SEC sent Kik a Wells notice<\/a> \u2014 a letter from the Enforcement Division notifying a company of a planned action, and asking for a submission as to why the action should not proceed.<\/p>\n

Kik sent a 39-page response<\/a> on 10 December 2018. They argued that Kin was a currency, and therefore not a security \u2014 which is why they did full know-your-customer checks on all purchasers, and paid sales tax on the purchases. Kik’s auditor, KPMG, told them that the company’s stock of Kin tokens was “inventory.” Kik compared Kin to Bitcoin and ether \u2014 which are treated in the US as commodities,<\/a> or perhaps value substituting for currency,<\/a> but not as securities.<\/p>\n

By January 2019, Kik was telling the Wall Street Journal<\/a> they were expecting an enforcement action \u2014 and they were going to fight it.<\/p>\n

In May 2019, Kik started DefendCrypto.org<\/a> \u2014 painting this coming SEC action as an existential risk to cryptocurrency, and asking for donations for defense. The company put up $5 million. Several crypto firms, including exchanges, got on board.<\/p>\n

The SEC suit<\/h3>\n

The SEC’s suit<\/a> (PDF) is 49 pages, but it’s a very clear and easy read. Non-lawyers should be able to follow the claims just fine.<\/p>\n

The SEC is not<\/em> claiming fraud, or even misrepresentation, on the part of Kik \u2014 they are only<\/em> claiming that Kik made and sold an unlicensed offering of securities in the US.<\/p>\n

The suit concentrates on how Kik marketed<\/em> Kin:<\/p>\n

9. From the initial May 2017 announcement through September 2017, Kik relentlessly pitched Kin and the prospect that Kik\u2019s future efforts to develop the Kin Ecosystem would drive an increase in Kin\u2019s value. Kik emphasized that only a finite number of tokens would be created and that rising demand for the tokens would cause their value to appreciate. … Kik also assured prospective buyers that, following distribution of the tokens, buyers would be able to trade Kin on secondary trading platforms, often described as \u201cexchanges,\u201d enabling conversion of Kin to either a digital asset (e.g., Bitcoin or Ether) or fiat currency (e.g., U.S. dollars).<\/p><\/blockquote>\n

Livingston described Kik\u2019s \u201ccrypto story\u201d similarly to employees in February 2017:<\/p>\n

46. \u2026 He wrote that the company would \u201csell some [tokens] to crypto investors to raise money,\u201d and that 11\u201c[m]ore demand\u201d for the token would mean \u201c[v]alue goes up\u201d and, therefore: \u201cBuy today, sell tomorrow, profit.\u201d<\/p>\n

47. … [I]f you buy some Kik Points today when the demand is low, then you will be able to sell them at a higher price tomorrow when the demand is higher, creating a return. This potential return encourages investors to \u201cbuy in\u201d at an ICO.<\/p><\/blockquote>\n

(Yeah, Livingston literally said “value goes up”.<\/a>)<\/p>\n

Kik specifically targeted crypto speculators:<\/p>\n

43. From the outset, Kik saw investors and speculators as a crucial target audience for an ICO. For example, in a meeting on February 16, 2017, Kik\u2019s executives and directors discussed the need to craft an offering that would appeal to \u201ccryptoinvestors\u201d and the growing market for \u201ccryptoassets,\u201d highlighting a \u201c50% three-year CAGR [compound annual growth rate]\u201d for such investments. At this meeting, Kik executives and directors anticipated that \u201cCrowdfunders\u201d \u201cwould invest in tradable digital tokens of a non-blockchain company if offered good risk-return potential.\u201d<\/p><\/blockquote>\n

The usual way to avoid problems with the SEC over your ICO is to file a Form D, claiming exemption from registration under Section 506(c), because you’re only selling to “accredited investors” \u2014 rich people and companies, who can buy all the magic beans they want, and on their own heads be it.<\/p>\n

Kik had filed a Form D<\/a> on 11 September 2017 \u2014 but the offering was already part of the larger non-exempt offering to the general public, so their Form D wasn’t valid.<\/p>\n

The SEC is asking for a civil penalty against Kik, an order that Kik “disgorge its ill-gotten gains and to pay prejudgment interest thereon,” and that they be permanently enjoined from doing this ever again.<\/p>\n

What happens next?<\/h3>\n

If you think your regulator is wrong, it’s completely appropriate to fight back!<\/p>\n

But all uninvolved observers think Kik is basically buggered here. The messages the SEC quotes are smoking guns for intent, not just behaviour.<\/p>\n

Kik’s December 2018 response to the Wells letter does not seem to me to address the claims the SEC puts forward in the June 2019 suit. Kik may well use these arguments \u2014 but I’d think they’ll need new ones too. Particularly if they want to argue that the Howey Test \u2014 of what constitutes a security \u2014 is outdated, and shouldn’t apply to some ICO offerings.<\/p>\n

Kik has put out a press release<\/a> responding to the SEC suit (full text<\/a>) \u2014 in which they hold that the SEC is using “flawed legal theory” as to … what constitutes a security. I think this is what judges call a novel<\/i> argument.<\/p>\n

If I were looking for a test case … I wouldn’t pick this one. It seems Coinbase think so too \u2014 the Coinbase logo has disappeared<\/a> from DefendCrypto.org.<\/p>\n

Kik’s situation isn’t hopeless \u2014 but riding this all the way to court is also a “hail Mary pass.” But I’m sure they still have all that $99 million to return to investors, and haven’t spent it all or anything.<\/p>\n

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It would probably help if the CEO hadn’t literally said “value goes up”.<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"inline_featured_image":false,"jetpack_post_was_ever_published":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[1],"tags":[9,30,380,189,33],"class_list":["post-13647","post","type-post","status-publish","format-standard","hentry","category-uncategorised","tag-ico","tag-kik","tag-kin","tag-saft","tag-sec"],"jetpack_featured_media_url":"","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/posts\/13647","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/comments?post=13647"}],"version-history":[{"count":39,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/posts\/13647\/revisions"}],"predecessor-version":[{"id":13689,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/posts\/13647\/revisions\/13689"}],"wp:attachment":[{"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/media?parent=13647"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/categories?post=13647"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/davidgerard.co.uk\/blockchain\/wp-json\/wp\/v2\/tags?post=13647"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}