On October 1, 2020, the U.S. District Court for the Southern
District of New York (the “Court“) ruled
that in 2017, Canadian technology company, Kik Interactive Inc.,
violated U.S. federal securities laws when it conducted the US$100
million initial coin offering of its “Kin” tokens (the
“ICO“). The ruling states the ICO was an
illegal securities offering because the tokens were sold without a
registration statement or an exemption from registration as
required by U.S. securities laws. This decision confirms that, in
most circumstances, digital coin and token sales will be considered
securities offerings to which U.S. securities laws apply.
The Securities and Exchange Commission (SEC) began its
investigation of Kik in 2017 as a result of the company’s ICO
and filed a lawsuit in June 2019. The lawsuit alleged that
Kik’s ICO was an illegal securities offering because the tokens
were sold by public offering in the U.S. without a registration
statement as U.S. securities laws require.
Kik argued that Kin is not a security; it is a “utility
token” purchased for consumption purposes and not speculative
purposes. Kik maintained that Kin was intended to be used on a
digital network of services that would be developed using the ICO
proceeds. As Kin was not a security, it was not subject to
securities laws and the requirement to register the Kin tokens did
In May 2019, Kik launched a “Defend Crypto” campaign
and raised $5 million in crowdfunding to support its legal battle.
By the end of 2019, however, Kik faced serious financial pressure
from its fight against the SEC. This caused Kik to sell its app and
the vast majority of its employees. Kik stated the company is now
focused solely on its cryptocurrency, Kin.
For further background on the Kik ICO, refer to our June 5, 2019
Update, SEC Sues Canadian Company for Conducting
Illegal Token Offering, our August 30, 2017 Update, Initial Coin Offerings in Canada: The CSA
Weighs In, our September 12, 2017 Update,Cryptocurrencies: Further Legal
Developments, and our December 6, 2017 Update, Read This Before Your ICO: Exploring the SAFT
Framework for Compliant Token Sales in Canada.
The Court’s Ruling
The Court held that the ICO violated the U.S. Securities Act of
1933 (the “Securities Act“) when Kik
failed to register the sale of Kin tokens in connection with the
ICO because Kin is a security.
Under the Securities Act, the definition of security includes an
“investment contract”. To determine what constitutes an
investment contract, the Court relied on the “Howey” test
established by the U.S. Supreme Court in SEC v. Howey. The
Howey test defines an investment contract as (i) an investment of
money, (ii) in a common enterprise, (iii) with profits to be
derived solely from the efforts of others.
The Court considered it uncontroversial that the ICO involved an
investment of money, satisfying the first element of the Howey
test. Next, the Court found that Kik established a common
enterprise when it deposited the funds into a single bank account
and used the funds to create the digital ecosystem it promoted.
This was a critical point because “the success of the
ecosystem drove demand for Kin and thus dictated investors’
profits,” satisfying the second element of the Howey test.
Finally, and possibly most importantly, Kik made repeated public
statements extolling Kin’s profit-making potential through
increasing demand for Kin, and explained how Kin would be tradeable
on cryptocurrency exchanges. These statements contradicted the view
that Kin is merely a “utility token”. The third element
of the Howey test was therefore satisfied.
In addition, the Court found that Kik’s private pre-sale
round of Kin tokens pursuant to a Simple Agreement for Future Token
(SAFT) before the ICO also amounted to an unregistered offering of
securities and did not qualify for any exemptions. The pre-sales
took place immediately before the ICO and the proceeds from both
sales went towards the same general purpose. The Court concluded
that “the two consecutive sales were part of a single plan to
introduce Kin and jumpstart the Kin economy” and should
therefore be viewed as a single integrated offering of securities
that violated the Securities Act.
The Court confirmed the SEC’s long-held position that U.S.
securities laws apply to the sale of digital tokens where such
sales constitute an investment contract under the Howey test. The
decision echoed the views of the SEC that many digital token sales
create investment contracts that constitute securities under the
Howey test and must be registered with the SEC before a public
offering. Absent the issuance of a pure “utility token”
with none of the indicia of an investment contract, an issuer risks
that the token offering will be offside securities regulation.
The decision also indicates that private pre-sale rounds of
token financing under the SAFT structure will not be exempt from
registration where they are effectively part of a single ICO
transaction in which securities are offered to the public, even if
the SAFT pre-sale is conducted as an exempt securities offering in
compliance with U.S. securities laws. By treating the pre-sale
round and the ICO as a single integrated offering, the decision
raises questions about whether SAFTs can effectively separate the
sale of a right to acquire tokens from the subsequent distribution
of the tokens themselves. If nothing else, the Court’s
conclusion makes it clear that token issuers who wish to engage in
pre-sales using the SAFT structure, must be very careful to ensure
the SAFT sale is a separate, stand-alone transaction that is
clearly separate from any subsequent token distribution.
Kik commented it is considering appealing the decision,
remaining adamant that the public sale of Kin was a sale of a
functional currency and not a securities offering. The earliest
time for it to file an appeal is after October 20.
Goodmans Tech Group
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and media, cleantech, tax, litigation, human resources, corporate
restructuring and administrative law. We do so both for innovative
businesses in their start-up phase and for well-established
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technology sector and is partnered with the DMZ at Ryerson
University. The DMZ is a leading business incubator (selected by
UBI as the top-ranked university incubator in the world), which
connects its start-ups with resources, customers, advisors,
investors, and other entrepreneurs. Goodmans is also a proud
partner of IDEABoost, an initiative of the Canadian Film
Centre’s Media Lab; building the next generation of
technology-based media entertainment products, services and brands.
Through these partnerships, Goodmans provides legal advice,
mentorship and networking opportunities to assist start-ups in
maximizing their potential.
Goodmans is also an internationally recognized leader in other
aspects of technology law and transactions. From our thought
leadership, through participation on the Boards of associations
such as CanTech (Canadian Technology Law Association), CORE (Centre
for Outsourcing Research and Education), CIEG (Canadian Institute
for Exponential Growth, which organized the Summit) and iTechLaw
(International Technology Law Association), to our involvement in
major technology procurement, joint venture and outsourcing
transactions, to our representation, in court proceedings and in
arbitrations, of major technology providers, and users of
technology, in ground-breaking cases, our Technology Group is
consistently at the forefront of leading technology transactions
Members of our Technology Group are recognized as leading
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Leading 500 Lawyers in Canada, teach internet and communications
law at Canada’s largest law schools, are regular lecturers at
technology industry events and legal conferences, and have
published articles in the technology law field.
For more information about this development, please contact any
member of our Technology Group.
The content of this article does not constitute legal advice
and should not be relied on in that way. Specific advice should be
sought about your specific circumstances.