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Rescission in the Age of Cryptocurrency

In a recent report of investigation, the U.S. Securities and Exchange Commission weighed in for the first time on the circumstances under which a virtual currency token will be deemed a security and subject to the federal securities laws.[1] The implications are far-reaching: any cryptocurrency token deemed to be a security must be registered with the SEC or otherwise eligible for an exemption from registration requirements; issuers and other participants involved in the sale of unregistered cryptocurrency-securities may be subject to liabilities and other remedies under state and federal securities laws. This article discusses the remedy of rescission and its application to the sale of unregistered cryptocurrency tokens in violation of the securities laws.

Most states have statutes that provide a detailed rescission offer process to cure securities laws violations (also known as “blue sky” laws), and generally, offerees who reject a rescission offer lose the right of action to a refund.[2] In the federal context, rescission offers have been made with consideration of the Securities Act Section 12 right of rescission of a buyer in a fraudulent transaction (e.g., making a materially misleading statement in the offering materials, including on a webpage) and/or one involving a technical violation (e.g., offering unregistered securities outside of a private placement or other exemption from registration). Importantly, regardless of whether or not a rescission offer is made, rescission cannot be used to eliminate liability. The federal securities laws expressly prohibit “any condition, stipulation, or provision binding any person to waive compliance” with securities laws, including any rules of self-regulatory organizations.[3]

The SEC has previously issued guidance regarding this dynamic between state and federal law (via no-action relief). With regards to rescission offers by a company seeking to “cure” defective offerings,[4] the SEC acknowledged such a right under state law yet declined to weigh in on whether a rescission offer in itself could lessen future liability and reiterated “its previously-expressed view that liabilities under the Federal securities laws, including the civil liabilities arising under Section 12 of the Act, are not terminated merely because potentially liable persons make a registered rescission offer with a prospectus meeting the requirements of Section 10 of the Act.”[5] In a separate no-action letter, the SEC also declined to weigh in with respect to the rights of purchasers who rejected a rescission offer from the issuer/seller.[6] Furthermore, in a 2005 enforcement action against Google that was ultimately settled, the SEC stated that "a rescission offer does not cure a violation of Section 5."[7]

While the SEC has declined to eliminate liability when a purchaser rejects a rescission offer, two circuit courts have held that purchasers who rejected rescission offers consequently waived their rights to a further action under federal securities laws.[8] Notwithstanding the aforementioned lack of clear guidance from the SEC, and the dearth of federal case law, if a rescission offer is accepted and such offer is for the amount specified in Section 12, it follows that a token purchaser who accepts such rescission offer would have no more amounts to recover.

In an attempt to mitigate the risk of a rescission offer in the event that the token is later deemed to be a security, some token purchase agreements for recent initial coin offerings (ICOs) and presales contain language that attempts to disclaim liability and prospectively remove the possibility of rescission, stating that token purchases are irreversible and there is “no refund under any circumstances.” Other token issuers characterize the payments received from token buyers as nonrefundable donations, using a Switzerland foundation as the legal entity. However, caveat emptor or “buyer beware” has its limitations, and token issuers cannot contract out of compliance with securities laws, including Section 12 rescission.

The remedy of rescission is further complicated by the fact that cryptocurrency token ICOs and offerings generally accept only certain other cryptocurrencies as consideration for the new token being offered; typically bitcoin, bitcoincash, ethereum and litecoin are the only accepted form of payment. This wrinkle presents a unique question complicated by the volatility of bitcoin: must the issuer return the number of bitcoins received per token at the time of purchase or the dollar/bitcoin exchange rate at the time of purchase? Ultimately, this may be an issue to be decided by the regulators or the courts. While some purchase agreements require that the purchaser waive the right to receive a return of their cryptocurrency paid for the token and limit liability to the equivalent value in U.S. dollars paid at the time of purchase, the enforceability of those provisions is uncertain.

In a market where there is a tendency for issuers to mimic and then seek to creatively improve upon their predecessors, both in terms of technology and offering structure, issuers should seek legal counsel and should not assume that a predecessor’s purchase agreement is acceptable and then simply use that agreement with slight modifications. Efforts to standardize purchase agreements for ICOs and ITOs should also be approached with caution, as many cryptocurrencies, their related protocols and offering structures have nuances that could determine whether such cryptocurrency tokens are securities.

By Robert Pommer and Darren Sandler

[1] The report described the SEC’s investigation of The DAO, a virtual, unincorporated, for-profit organization that uses distributed ledger or blockchain technology to offer and sell “DAO Tokens” to investors. SEC Release No. 81207 (July 25, 2017); https://www.sec.gov/litigation/investreport/34-81207.pdf.

[2] The Uniform Securities Act of 1956, § 410(e). See also Michelle Rowe, “Rescission Offers Under Federal and State Securities Law,” 12 Journal of Corporation Law 383 (1987) and Stuart R. Cohn, “Counseling for Small & Emerging Companies” § 18:2 (2016).

[3] 15 U.S.C.A. § 77n; 15 U.S.C.A. § 78cc(a).

[4] See Clover Mini-Marts Inc., SEC No-Action Letter, 1985 WL 52008 (Feb. 2, 1985); Steiger Tractor, SEC No-Action Letter, 1975 WL 11392 (Aug. 21, 1975)

[5] See Steiger Tractor, SEC No-Action Letter, 1975 WL 11392 (Aug. 21, 1975)

[6] Clover Mini-Marts Inc., SEC No-Action Letter, 1985 WL 52008 (Feb. 2, 1985).

[7] In the Matter of Google Inc. and David C. Drummond, Securities Act of 1933 Release No. 8523 (Jan. 13, 2005), Admin. Proc. File No. 3-11795

[8] Topalian v. Ehrman, 954 F.2d 1125 (5th Cir. 1992); Meyers v. C & M Petroleum Producers Inc., 476 F.2d 427 (5th Cir. l973)

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