On July 25, 2017, the Securities and Exchange Commission (the SEC) released its Report of Investigation (the “SEC Report”) on the 2016 offering of tokens by a group known as “the DAO.” The SEC determined that the tokens offered by the DAO (“DAO Tokens”) were investment contracts, and therefore were securities under the United States Securities Act of 1933 and the Securities Exchange Act of 1934.
The DAO, prior to its demise at the hands of hackers in June 2016, was an example of a decentralized autonomous organization – that is, a ‘virtual’ organization not existing in a physical form, but rather embodied in computer code and executed on a distributed ledger or blockchain. The purported premise behind the DAO was to remove decision making authority from a board of directors in both commercial and non-profit enterprises, and place it directly in the hands of owners of the DAO Tokens in an attempt to reduce the misdirection and misuse (or waste) of resources that its promoters argued plague large organizations where control is concentrated in the hands of the few. In its initial coin offering (“ICO”), the DAO offered and sold approximately 1.15 billion DAO Tokens.
In the United States, there are three factors that must be present in order to make a determination that an ‘investment contract’ exists: (i) an investment of money in a common enterprise; (ii) with a reasonable expectation of profits; (iii) derived from the managerial efforts of others. This test was established in SEC v W.J. Howey Co. (“Howey”). The SEC Report concluded that the offering of DAO Tokens and the rights bestowed on holders qualified them as ‘investment contracts’.