The US Securities and Exchange Commission has issued an investor alert about initial exchange offerings, stating that they may be lacking many of the investor protections of registered and exempt securities offerings and violate federal securities laws.
IEOs are similar to initial coin offerings but digital tokens or coins are offered directly by online trading platforms on behalf of companies for a fee.
Last year, IEOs replaced most initial coin offerings in the crypto asset space, after a large number of ICOs were found to be fraudulent or the tech projects simply did not live up to the hype they had generated.
The first exchange offerings were very successful at raising funds with demand often outstripping supply. Bittorrent’s IEO, the first on Binance Launchpad, met its funding goal of US$7.2 million in a matter of minutes.
IEOs were touted as an innovation because of benefits they provide to exchanges, issuers and investors.
Tokens offered in an IEO are immediately tradable and give more publicity to projects, plus exchanges gave investors some comfort by promising to vet the coins they offer on their platform.
But the SEC said in its alert that claims that IEOs are vetted by trading platforms could be used improperly to entice investors with the false promise of high returns in a new investment space.
“The past few years have seen opportunistic fraudsters take advantage of the quickly evolving investment space around digital assets, ‘cryptocurrencies’ and ICOs to conduct fraudulent schemes. The development of IEOs provides a similar opportunity for fraudsters,” the securities regulator said.
The SEC said IEOs may have to be registered with the regulator, which includes the disclosure of information about the company and its business, the digital asset offered, and the terms of the offering to investors. Any exchanges that offer IEOs involving securities may also need to register with the SEC as a national securities exchange or alternative trading system. And those offering brokerage services would have to register as broker dealers.
“The federal laws and regulations governing registered national securities exchanges and alternative trading systems (ATS) are designed to protect investors and prevent fraudulent and manipulative trading practices. Many online trading platforms may give the misimpression to investors that they are registered or meet the regulatory requirements for a national securities exchange or ATS, and therefore may lack the investor protections that a national securities exchange or an ATS provide to investors,” the SEC stated in its alert.
Investors should carefully consider whether the company and the trading platform involved in the IEO has complied with federal securities laws, the SEC said, advising that it was a red flag if the applicability of these laws had not been addressed.
Any offering claiming to avoid the US federal securities laws because it is occurring on an overseas trading platform while allowing US citizens to invest was also a red flag, the regulator said.
Investors should also be mindful that they may have no effective legal remedies in US courts against offshore trading platforms or IEOs issuing on the platforms. Even if investors successfully sued in a US court, they may not be able to collect on a US judgment against a foreign company, entity or person, the SEC warned.