SEC Set an ICO Compliance Template in Airfox and Paragon Settlements

The U.S. Securities and Exchange Commission on November 16, 2018 imposed $250,000 civil penalties on each of two initial-coin-offering issuers, CarrierEQ Inc., doing business as Airfox, and Paragon Coin Inc. The settlements were the agency’s first cases imposing civil penalties solely for failures to register ICO securities offerings.

The action mattered beyond the two relatively small issuers. The SEC paired the orders with a three-division statement that presented a compliance route for token sellers whose unregistered offerings were already complete: register the tokens as a class of securities, provide continuing public disclosures and offer eligible purchasers a process to seek repayment. That combination turned earlier warnings about token sales into a concrete remediation template.

Two offerings, the same registration failure

Airfox sold AirTokens between August and October 2017 and raised approximately $15 million in digital assets. It said proceeds would finance an international mobile-data ecosystem in which users could earn tokens by viewing advertisements, transfer them, and eventually use them for other goods and services. The SEC order found that Airfox also promoted potential appreciation and secondary-market liquidity.

Paragon raised $12.066 million in digital assets from approximately 8,323 investors during an offering that ran from August 15 through October 15, 2017. Its plan combined blockchain products with the cannabis industry. The order said Paragon described how its work could increase PRG’s value, advertised secondary trading and distributed the ERC-20 tokens on October 22, 2017.

The Commission found that both token sales were investment-contract offerings under the test derived from SEC v. W.J. Howey Co. Purchasers supplied value while expecting profits from each company’s promised managerial and entrepreneurial work. Neither issuer had a registration statement in effect or qualified for an exemption, the orders said, producing violations of Sections 5(a) and 5(c) of the Securities Act.

Airfox and Paragon settled without admitting or denying the findings, apart from accepting the SEC’s jurisdiction and the proceeding’s subject matter. The orders were administrative settlements and cease-and-desist directives, not fraud judgments or criminal convictions.

Registration, disclosure and a claims process

Each issuer agreed to file a Form 10 within 90 days to register its token under Section 12(g) of the Securities Exchange Act. Each also had to maintain the registration and make required periodic reports for at least one year after effectiveness, subject to the orders’ termination conditions.

The investor remedy was conditional rather than an automatic blanket refund. Airfox was required to notify people and entities that bought AirTokens from the company through October 5, 2017; Paragon had the parallel obligation for direct PRG purchasers through October 15, 2017. Claimants would receive a defined filing window and could seek the consideration paid plus interest, less income received, or damages if they no longer held the token. The issuers had to report claims and payments to SEC staff.

That structure supplied information investors had not received before the offerings. Registration under the Exchange Act would create ongoing disclosure while the claims process let purchasers decide whether to tender their tokens or retain them. It did not validate either business model, guarantee liquidity or establish that every digital token was a security.

A broader message to the token market

In a same-day statement, the SEC’s Corporation Finance, Investment Management, and Trading and Markets divisions placed the settlements within a wider framework covering token issuance, crypto investment vehicles and secondary trading. Their central message was that blockchain-based instruments remained subject to the existing federal securities-law framework when the facts made them securities.

The distinction from the SEC’s December 11, 2017 Munchee order was important. Munchee stopped its offering before token delivery, returned proceeds and received no civil penalty. Airfox and Paragon had completed their sales and distributed tokens, so the November 16 orders addressed how an issuer might remediate an ongoing registration problem after the capital had been raised.

What was knowable on November 16 was therefore narrower than a universal classification of crypto assets, but more consequential than another warning. The Commission had imposed monetary penalties for registration violations alone and attached a repeatable package of registration, periodic reporting and purchaser claims. For the ICO market, compliance after an unregistered sale now had an observable cost and process.