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Regulatory Scrutiny of the ICO Market – What Fund Managers Should Know

Last week, former CFTC Chairman Gary Gensler explained in remarks at M.I.T. that he believes the second and third most widely used virtual currencies—Ether and Ripple—may have been issued and traded in violation of securities regulations. This comes on the heels of a crackdown on cryptocurrency-related securities by the SEC, which is particularly focused on initial coin offerings (ICOs). For fund managers, we believe the increased regulatory pressure will be felt in some expected, and some not-so-expected, ways. 

ICO enforcement is trending: The SEC’s Cyber Unit has ramped up enforcement pressure, issuing dozens of subpoenas and information requests to technology companies and advisers involved in the ICO market. The requests have sought information about the structure for sales and pre-sales of ICOs.  This uptick in enforcement pressure isn’t surprising, especially given Chairman Clayton’s repeated warnings that participants in the ICO space are not complying with the required securities laws (for example, notably stating that he has yet to see an ICO that “doesn’t have a sufficient number of hallmarks of a security.”)  There are no signs the SEC will slow down its scrutiny of crypto-related assets. The SEC has already indicated that it will devote significant resources to policing the ICO market.

  • SEC and CFTC enforcement cases have to date focused on the anti-fraud provisions, involving traditional types of schemes (offering frauds, market manipulation) feeding on interest in new technology.
  • Clayton has repeatedly warned attorneys and other advisors involved in structuring ICOs to stop advising their clients that these instruments don’t need to be registered.
  • The SEC is looking at potential registration issues for ICOs, under the principle that every offering of securities must be registered or subject to a valid exemption.
  • Businesses operating as ICO exchanges or advising on ICO investment decisions may have to consider registration under the Securities Exchange Act of 1934, the Investment Company Act of 1940 or the Investment Advisers Act of 1940.
  • The SEC’s Section 21(a) report of investigation regarding The DAO sets out the framework for how the Commission is likely to analyze whether a crypto coin or token is a security.

As such, those who interface with this market in any way should beware that they can face heightened scrutiny merely by virtue of their involvement with these instruments.

OCIE exam focus is also high: The Office of Compliance Inspections and Examinations is following the lead of the Chairman, but with a different focus. It has been publicly reported that the exam staff intends to examine up to 100 fund managers as part of a sweep of crypto-focused funds. However, while SEC examiners could refer any red flags they observe to enforcement investigators, the effort is principally to inform the Commission how to address the new world of cryptocurrency investments.  Two key areas of focus are likely to come to light:

  • Have cryptocurrency related risks been adequately disclosed to LPs in offering docs (i.e., potential investment losses, liquidity risks, price volatility, hacker-related frauds, etc.)?
  • Are there adequate risk management policies and procedures that have been put in place by firms registered with the Commission given novel issues implicated by crypto-related investments?

To this end, fund managers should be prepared to explain how disclosures to LPs adequately reflect the risks involved in any crypto-related investments. Because of the potential for regulatory spillover, fund managers should satisfy themselves that investments in this space comply with applicable laws and regulation—the question will be asked.

Regulatory uptick has been felt by the market: This increasing regulatory pressure appears to be affecting the market—while the number of ICOs in March dipped only slightly, the gross proceeds were only $795 million—a 45% decrease from the $1.44 billion raised in February.   This decrease may signal a shift to a higher degree of “pre-sale” fundraising, mainly focusing on institutions and accredited investors—often through Simple Agreements for Future Tokens (or SAFTs), which have also garnered significant regulatory attention. However, given the increasing focus on this area (along with crypto-related investments in general), fund managers should be sure to commit the upfront effort to carefully analyze emerging regulatory risks.

© 2020 Proskauer Rose LLP.


About this Author

Joshua Newville, Proskauer Rose, regulatory enforcement attorney, industry compliance legal counsel, securities exchange commission lawyer

Joshua M. Newville is a partner in the Litigation Department in New York. His practice focuses on commercial litigation and regulatory investigations. Mr. Newville advises companies and individuals in securities litigation and compliance matters. He also focuses on internal investigations and enforcement matters. Prior to joining Proskauer, Josh was senior counsel in the U.S. Securities and Exchange Commission’s Division of Enforcement, where he investigated and prosecuted violations of the federal securities laws. Josh served in the Enforcement Division’s Asset...

Anthony M. Drenzek, Special regulatory Counsel, Proskauer Rose, Attorney, Finance Policy Lawyer
Special Regulatory Counsel

Tony is special regulatory counsel in the Corporate Department and a member of the Private Funds Group and the Private Equity & Hedge Fund Litigation team. His practice focuses on advising U.S. and offshore private fund managers on all aspects of federal, state and SRO organizational and operational compliance, with a specific emphasis on the Investment Advisers Act of 1940.

Tony assists U.S. and offshore private fund clients in registering with the SEC as investment advisers, or reporting as exempt reporting advisers, and complying with CFTC and various U.S. state registration and notice-filing requirements. He also assists on structuring fundraising transactions to comply with the U.S. offering exemptions available under Regulation D and Regulation S.


Tony proactively monitors the evolving regulatory landscape and counsels clients on practical industry approaches to compliance and how anticipated trends in agency rulemaking and staff expectations may affect their operations. He counsels clients on the establishment, implementation and evaluation of regulatory programs required under the Investment Advisers Act of 1940. In addition to compliance manuals and codes of ethics, Tony assists on the creation and maintenance of various operational-level compliance policies and procedures in areas such as investment and expense allocation policies, investment valuation procedures, cybersecurity policies, and business continuity and transition plans.

As clients’ investment management practices mature, Tony advises on the regulatory aspects of transactions involving divestments, mergers and acquisitions of investment managers and fund complexes. This includes coordinating and amending applicable regulatory filings and assuring that client consent requirements are evaluated and compliant.

As a member of the Private Equity & Hedge Fund Litigation team, Tony has advised clients on responses to inquiries and investigations from federal and state regulatory agencies on various regulatory matters, including the Investment Advisers Act’s pay-to-play and custody rule requirements.

Tony has authored and co-authored numerous articles on various regulatory matters affecting private fund sponsors, including several published in the Hedge Fund Law ReportPrivate Funds ManagementCompliance WeekVC Experts and Law360.

Prior to joining Proskauer, Tony served as an associate director of the Massachusetts Securities Division and was appointed as a Special Assistant Attorney General in the Commonwealth of Massachusetts. Between 2008 and 2013, Tony was an adjunct professor in the Law, Taxation and Financial Planning Department at Bentley University in Waltham, where he developed and taught a course focusing on application of the Securities Act of 1933 and the Securities Exchange Act of 1934.

Brian Hooven, Proskauer, Litigation, Expert Witness Qualifications Attorney

Brian Hooven is an associate in the Litigation Department.

  • Columbia Law School, J.D., 2015 

  • Journal of Law and Social Problems

  • University of Michigan, B.S., 2011