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<p>The Kik lawsuit vs the Securities and Exchange Commission (SEC) got even uglier with <a href="https://www.thecrowdfundinglawyers.com/sec-goes-for-kik-will-it-get-knifed/">Kik’s</a> <a href="https://cdn.crowdfundinsider.com/wp-content/uploads/2019/08/SEC-v-Kik-Interactive-Anser-to-Complaint-8.6.19-Case-119-cv-05244-AKH.pdf">latest reply</a>. Indeed, the company <a href="https://www.coindesk.com/kik-says-sec-twisted-facts-about-100-million-token-sale">accused</a> the SEC of “playing dirty,” and claimed the dreaded Enforcement Division was seeking favorable “news cycles” not blind justice.&nbsp; </p>
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<p>Of course, in theory the elected and judicial branches police alleged agency abuses. Reality is a different story. And the SEC’s tortured path to token securities shows how. </p>
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<p>But instead of Congress or courts setting borders to cabin the SEC, the Commission has played unsupervised. It has produced a mishmash of conference statements, enforcement actions, tea-leaf reading, and finally <a href="https://www.thecrowdfundinglawyers.com/amy-winehouse-to-valerie-szczepanik-come-on-over/">“guidance”</a> that confused more than enlightened. </p>
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<div class="wp-block-image"><figure class="aligncenter"><img src="https://www.thecrowdfundinglawyers.com/wp-content/uploads/2019/05/dwight-3.gif" alt="" class="wp-image-417"/></figure></div>
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<p>The SEC should have shunted token rules through a rulemaking
where affected parties comment. And would-be issuers can immediately challenge without
pain of enforcement processes. Instead emerged the SEC’s Horsemen of Reaction: Chairman
<a href="https://www.thecrowdfundinglawyers.com/shallow-end-jay-treads-water-while-reg-cf-sinks-but-is-help-on-the-way/">‘Shallow-End
Jay’</a> Clayton, Senior Advisor for Digital Assets and Innovation <a href="https://www.thecrowdfundinglawyers.com/amy-winehouse-to-valerie-szczepanik-come-on-over/">‘NPC
Valerie’</a> Szczepanik, and Corp Fin Director ‘Bill the Butcher’ Hinman. </p>
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<p>And that is why the Kik lawsuit is so important. <a href="https://www.thecrowdfundinglawyers.com/sec-goes-for-kik-will-it-get-knifed/">Kik’s</a> present resolve to fight through trial allows courts to review the Commission’s legal and policy bearings. And prime among them is where decentralization fits in the securities milieu. </p>
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<h3 style="text-align: center;"><strong>Kik lawsuit enables court to judge decentralization as a <em>Howey</em> extension</strong></h3>
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<p>The SEC and courts use the dated <em>Howey</em> test to determine
what products are securities. The test has four parts: (1) a contract,
transaction, or scheme (2) whereby a person invests money, (3) in a common
enterprise, and (4) expects profits solely from the efforts of others. </p>
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<p>But it’s not that simple. The courts urged by government
enforcers have oft twisted the factors. For instance, the first part needn’t include
a “contract,” the second needn’t include “money,” no one takes “solely”
seriously and so on. </p>
<!-- /wp:paragraph -->

<!-- wp:paragraph -->
<p>Decentralization ideally rids “efforts” from the fourth prong
thereby removing the securities status from ‘investment contracts.’ But as the <a href="https://www.thecrowdfundinglawyers.com/competitive-enterprise-institute-criticizes-sec-shallow-end-jay-for-crypto-intransigence/">Competitive
Enterprise Institute</a> and others show, the <em>Howey </em>test doesn’t include
decentralization. </p>
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<h3 style="text-align: center;"><strong>Bill the Butcher announced decentralization at a San Francisco shindig&nbsp;</strong></h3>
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<!-- wp:paragraph -->
<p>How did it get there? In typical commission fashion, Bill the Butcher, a staff-level functionary exclaimed this new criterion at a fancy San Francisco conference where security (the kind with badges) block the <em>hoi polloi</em>. And the ruling class pay upwards of $1,000 to attend. While discussing the Ethereum network last year he <a href="https://www.sec.gov/news/speech/speech-hinman-061418">remarked</a>: </p>
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<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>If the network on which the token or coin is to function is sufficiently decentralized — where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts — the assets may not represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.</p></blockquote>
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<p>. . .</p>
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<blockquote class="wp-block-quote"><p>Based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions, and, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value. Over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required.</p></blockquote>
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<h3 style="text-align: center;"><strong>The SEC Horsemen of Reaction stick together&nbsp;</strong></h3>
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<!-- wp:paragraph -->
<p>And when forced, <a href="https://www.thecrowdfundinglawyers.com/shallow-end-jay-treads-water-while-reg-cf-sinks-but-is-help-on-the-way/">Shallow-End Jay</a> backed him in a <a href="https://coincenter.org/files/2019-03/clayton-token-response.pdf">public letter</a>: </p>
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<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>I agree with Director Hinman’s explanation of how a digital asset transaction may no longer represent an investment contract, if for example, purchasers would no longer reasonably expect a person or group to carry out the essential managerial or entrepreneurial efforts. Under those circumstances, the digital asset may not represent an investment contract under the <em>Howey </em>framework.</p></blockquote>
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<p><a href="https://www.thecrowdfundinglawyers.com/amy-winehouse-to-valerie-szczepanik-come-on-over/">NPC
Valerie</a> then issued widely panned “guidance”: </p>
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<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>There are essential tasks or responsibilities performed and expected to be performed by an AP [Active Participant, yet another SEC invention], rather than an unaffiliated, dispersed community of network users (commonly known as a "decentralized" network).</p></blockquote>
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<p>And just like that the <em>Howey</em> test expanded. </p>
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<div class="wp-block-image"><figure class="aligncenter is-resized"><img src="https://www.thecrowdfundinglawyers.com/wp-content/uploads/2019/08/Sponge-Bob-Amazing-GIF.gif" alt="" class="wp-image-3658" width="438" height="322"/></figure></div>
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<p>The Enforcement Division now cites “decentralization” <a href="https://cdn.crowdfundinsider.com/wp-content/uploads/2019/08/SEC-v-Kik-Interactive-Anser-to-Complaint-8.6.19-Case-119-cv-05244-AKH.pdf">in
pleadings</a>: </p>
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<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>At the time of all these [token] sales, there was nothing to purchase using Kin, and critical elements of the decentralized economy that Kik had marketed – including a blockchain capable of processing transactions between buyers and sellers at the volume and speed necessary for running consumer applications, and a functioning rewards engine – did not exist.</p></blockquote>
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<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>Ultimately, Kik pursued the ICO without first achieving a decentralized economy for Kin, and without even ensuring that investors would be able to buy goods and services with the tokens upon their receipt.</p></blockquote>
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<h3 style="text-align: center;"><strong>Decentralization is good, clear rules applied evenly are better</strong></h3>
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<!-- wp:paragraph -->
<p>Some applaud SEC willingness to provide a security-less
token pathway absent attendant expense and rules. &nbsp;</p>
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<!-- wp:paragraph -->
<p>But the Commission has not answered decentralization
questions. And perhaps it has not even considered them. </p>
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<!-- wp:paragraph -->
<p>The theory behind the decentralization comes from blockchain features. Blockchain ecosystems don’t function like normal issuers. Indeed lots of parties play substantive roles including miners, nodes, developers, and users. Thus, onerous disclosures <a href="https://www.lawandblockchain.eu/hinman-test/">don’t make sense</a> when issuers have scant control. In the Bill the Butcher’s words, it wouldn’t be “meaningful.”</p>
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<h3 style="text-align: center;"><strong>Kik lawsuit should answer how SEC applies decentralization to blockchain issuers</strong></h3>
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<p>But the theory invites lots of theoretical and real-world
problems. And the SEC fallback of relying on individual “facts of
circumstances” welcomes bias and arbitrary enforcement as the Kik lawsuit <a href="https://cdn.crowdfundinsider.com/wp-content/uploads/2019/08/SEC-v-Kik-Interactive-Anser-to-Complaint-8.6.19-Case-119-cv-05244-AKH.pdf">claims</a>.
</p>
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<p>As <a href="https://ssrn.com/abstract=3326244">Angela Walch
asks</a>:</p>
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<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>When we talk about decentralization in context to the Hinman test, what do we refer to? Do we refer to the amount of developers involved in a project? To the amount of nodes? Amount of miners? Is it about the degree of influence the issuer has on the governance and future development of a project? Do we talk about the degree in which a token’s value is derived from businesses building on top of a protocol?</p></blockquote>
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<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>The system’s decentralization is in part a description of its governance [power] and part a description of the numerical, geographical, and ownership distribution of the computers within the network [physical attributes].</p></blockquote>
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<p>Hinman focuses on the network as the decentralizing factor:
“if the network…is sufficiently decentralized,” “as a network becomes truly
decentralized,” “[t]he network on which Bitcoin functions….appears to have been
decentralized for some time,” “based on my understanding of the present state
of Ether, the Ethereum network and its decentralized structure,” and “there may
be other sufficiently decentralized networks and systems”). As <a href="https://ssrn.com/abstract=3326244">Walch explains</a> Hinman conflates
the physical network as a gateway to explain power structure. </p>
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<h3 style="text-align: center;"><strong>In crisis Bitcoin and Ethereum centralize &nbsp;</strong></h3>
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<p>Adding to the confusion, Bill the Butcher seems not to consider Bitcoin and Ethereum crises that caused temporary but dramatic centralized moments. For instance, in the fall of 2018 programmers discovered a bug in Bitcoin’s software that could affect coin output and ultimately kill the network. </p>
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<!-- wp:paragraph -->
<p>A select group patched the bug in secret and got major mining pools on board minutes later. But the public didn’t know for days. And a similar hard fork occurred in 2013. </p>
<!-- /wp:paragraph -->

<!-- wp:paragraph -->
<p>Likewise, Ethereum forked after the infamous <a href="https://www.thecrowdfundinglawyers.com/sec-unleashes-hurricane-ico/">DAO fiasco</a>
to deny a hacker stolen tokens. And in 2018 an invitation-only meeting took
place to discuss Ethereum changes. </p>
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<!-- wp:paragraph -->
<p>In fact, Kik’s lawsuit argues under these metrics <a href="https://www.thecrowdfundinglawyers.com/sec-goes-for-kik-will-it-get-knifed/">Kin</a>
was more decentralized than either Bitcoin or Ether at the time of sale (or
introduction) and achieved higher trading volumes since. </p>
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<h3 style="text-align: center;"><strong>Kik lawsuit argues it’s as decentralized as others without legal troubles</strong></h3>
<!-- /wp:tadv/classic-paragraph -->

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<p>But there’s more. It is interesting to note similarities between
Kik’s lawsuit pleadings and <a href="https://www.thecrowdfundinglawyers.com/its-happening-the-blockstack-reg-a-token-sale-and-a-new-internet/">Blockstack</a>
and Brave statements, both devoid of legal troubles. &nbsp;</p>
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<p><strong>Kik</strong>: </p>
<!-- /wp:paragraph -->

<!-- wp:quote -->
<blockquote class="wp-block-quote"><p><a href="https://www.thecrowdfundinglawyers.com/sec-goes-for-kik-will-it-get-knifed/">Kik</a> sold Kik Points [precursor to Kin] to advertisers, who – rather than siphoning user data and using it to run targeted advertisements –would offer them as rewards to users who interacted with advertisers’ surveys or polls within Kik Messenger.</p></blockquote>
<!-- /wp:quote -->

<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>It envisioned a decentralized, widely adopted currency that would be used for earning and spending within a variety of digital services offered by developers.</p></blockquote>
<!-- /wp:quote -->

<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>[CEO Ted] Livingston reiterated that “the ultimate dream is for Kik to launch Kin, to launch this broader ecosystem, then for this broader ecosystem to not need Kik.”</p></blockquote>
<!-- /wp:quote -->

<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>In this vision, <a href="https://www.thecrowdfundinglawyers.com/sec-goes-for-kik-will-it-get-knifed/">Kik</a> would be just one of a vast number of participants in this new digital economy.</p></blockquote>
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<!-- wp:paragraph -->
<p><strong>Blockstack</strong>: </p>
<!-- /wp:paragraph -->

<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>Ultimately, <a href="https://www.thecrowdfundinglawyers.com/its-happening-the-blockstack-reg-a-token-sale-and-a-new-internet/">Blockstack</a> anticipates that the <a href="https://www.thecrowdfundinglawyers.com/its-happening-the-blockstack-reg-a-token-sale-and-a-new-internet/">Blockstack</a> network will become an independent, decentralized ecosystem, over which no one party, including Blockstack, will have control. Changes to the <a href="https://www.thecrowdfundinglawyers.com/its-happening-the-blockstack-reg-a-token-sale-and-a-new-internet/">Blockstack</a> Core will likely be proposed by third parties, without Blockstack’s approval</p></blockquote>
<!-- /wp:quote -->

<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>[A]s the <a href="https://www.thecrowdfundinglawyers.com/its-happening-the-blockstack-reg-a-token-sale-and-a-new-internet/">Blockstack</a> network becomes increasingly decentralized, core developers other than those employed by Blockstack may become primarily responsible for the development and future success of the network.</p></blockquote>
<!-- /wp:quote -->

<!-- wp:paragraph -->
<p><strong>Brave</strong> (from <a href="https://www.thecrowdfundinglawyers.com/what-will-life-be-like-after-google/">Life After Google</a>): </p>
<!-- /wp:paragraph -->

<!-- wp:quote -->
<blockquote class="wp-block-quote"><p>Into this breach [Brendan] Eich is hurling his one billion BATS—the unit of exchange for an ingenious new decentralized open-source and efficient digital advertising platform based on Vitalik Buterin’s Ethereum blockchain. Advertisers award BATS to publishers based on the attention of users measured by the pattern of their usage. Users too will be paid in BATS for acting ads that they want to see or choose to tolerate in exchange for micropayments. They can donate they BATS back to favored publishers or use them in exchange for content.</p></blockquote>
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<h3 style="text-align: center;"><strong>Kik Lawsuit should define rules everyone knows in advance</strong></h3>
<!-- /wp:tadv/classic-paragraph -->

<!-- wp:paragraph -->
<p>The easy answer is Brave is a closed system and <a href="https://www.thecrowdfundinglawyers.com/its-happening-the-blockstack-reg-a-token-sale-and-a-new-internet/">Blockstack</a>
played by the rules and got Reg A+ qualified. But Ethereum did neither. And it’s
hard tack to say as did <a href="https://www.sec.gov/news/speech/speech-hinman-061418">Bill the Butcher
did</a>, “putting aside the fundraising.” The SEC’s problem with Kik is “the fundraising.”
</p>
<!-- /wp:paragraph -->

<!-- wp:paragraph -->
<p>From the outside it appears unelected bureaucrats with
unlimited power deciding winners and losers based on <a href="https://www.thecrowdfundinglawyers.com/the-sec-mobilizes-for-war/">obeisance</a>,
media coverage, or worse. But this not to say Kik has clean hands. It <a href="https://www.thecrowdfundinglawyers.com/competitive-enterprise-institute-criticizes-sec-shallow-end-jay-for-crypto-intransigence/">knew
the risks</a> by avoiding certain jurisdictions. Moreover, it could have
stopped after its $50 million SAFT sale and sought a Reg A+ public sale. It
took a risk and is now rolling the dice in court. </p>
<!-- /wp:paragraph -->

<!-- wp:paragraph -->
<p>No one should oppose decentralization as a factor or perhaps the sole factor in when the magic transition happens. But it’s the government process that makes it distasteful. A court can better apply standards evenly and interpret rules openly and fairly. The Kik lawsuit should not leave Bill the Butcher, <a href="https://www.thecrowdfundinglawyers.com/shallow-end-jay-treads-water-while-reg-cf-sinks-but-is-help-on-the-way/">Shallow End Jay</a>, and <a href="https://www.thecrowdfundinglawyers.com/amy-winehouse-to-valerie-szczepanik-come-on-over/">NPC Valerie</a> to roam like unsupervised children in billion-dollar playgrounds. &nbsp; </p>
<!-- /wp:paragraph -->

<!-- wp:paragraph -->
<p>By <a href="https://twitter.com/thecrowdfundlaw">Jossey PLLC</a> via <a href="http://www.thecrowdfundinglawyers.com">www.thecrowdfundinglawyers.com</a></p>
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