Kin cryptocurrency. Photo: Shutterstock

The U.S. Securities and Exchange Commission is suing Canadian messaging and cryptocurrency company Kik Interactive for allegedly making an illegal $100 million securities offering through the launch of its Kin digital tokens. Kik, however, was already preparing for a court battle with the agency to determine whether the legal test that defines securities that come under the agency's jurisdiction applies to initial coin offerings.

The SEC claims that Kik should have registered the Kin ICO with the agency as a security since it met the definition of an offering under the so-called Howey test. Established in Securities and Exchange Commission v. W.J. Howey Co., the four-prong test determines when an asset qualifies as an “investment contract” based on if an exchange includes an investment of money, a common enterprise, an expectation of profits and is dependent on the efforts of others.

After years of back and forth with the commission over the ICO, Kik last week launched the Defend Crypto campaign, putting up $5 million of its own cryptocurrency funds toward potential litigation. The campaign has resulted in an additional $4.5 million in crowdfunding in assorted digital assets to fund a legal battle with the SEC.

“This is the first time that we're finally on a path to getting the clarity we so desperately need as an industry to be able to continue to innovate and build,” Kik CEO Ted Livingston said in an email Tuesday.

The agency's complaint filed in the U.S. District Court for the Southern District of New York alleges that Kik launched the digital asset to prop up its business and move away from its messaging app, which was losing users. The SEC claims Kik expected to run out of money by the end of 2017 if not for the 10,000 investors who purchased trillions of Kin tokens.

Kik reportedly compared the development of Kin with the high-risk, high-reward “dot.com era” in investor presentations. Additionally, the complaint notes that Kin distributed 30% of the supply of the digital asset to itself, to put both Kin and investors in a position to make money. By not registering the offer and sale of Kin as a security, the SEC claims consumers were shorted important disclosures on Kik's financial condition, future operational and budgetary plans, use cases for investor funds and material trends that made the offering a risky venture. The SEC also alleges that Kik did not follow through on promises to create a decentralized economy for Kin.

“Investors' purchases of Kin were an investment of money, in a common enterprise, with an expectation of profits for both Kik and the offerees, derived primarily from the future efforts of Kik and others to build the Kin Ecosystem and drive demand for Kin. Consequently, Kik's offer and sale of Kin in 2017 was an offer and sale of securities,” the SEC wrote in its complaint.

In January, the company decided to open up about its dealings with the SEC, publicly sharing its record with the agency, including a Wells Notice and settlement discussions.

Eileen Lyon, Kik's general counsel, said the complaint is based on flawed legal theory. “Among other things, the complaint assumes, incorrectly, that any discussion of a potential increase in value of an asset is the same as offering or promising profits solely from the efforts of another; that having aligned incentives is the same as creating a 'common enterprise'; and that any contributions by a seller or promoter are necessarily the 'essential' managerial or entrepreneurial efforts required to create an investment contract,” Lyon said in a statement. “These legal assumptions stretch the Howey test well beyond its definition, and we do not believe they will withstand judicial scrutiny.”

Last summer, William Hinman, head of the Division of Corporation Finance at the SEC, announced that bitcoin and ether were not securities, because of their decentralized networks. On the other hand, he said a digital offering is likely a security if it is conducted by a centralized third party and buyers anticipate a windfall. Overall, the cryptocurrency community is still seeking clarity on the issue.

Patrick Gibbs, partner at Cooley LLP who represents Kik, shared on the Unchained Podcast that the court process is a necessary step. “There's no question this process will take some time, but in the absence of the SEC giving appropriate and clear guidance itself, this is really the only option,” Gibbs said.

Gibbs did not respond to a request for comment at the time of publication.

The SEC seeks to permanently enjoin Kik from engaging in the alleged illegal behavior, disgorge the company of the money it made from the unregistered security offering and impose monetary civil penalties.

Read more:

CoinList General Counsel Joins Chorus of Blockchain/Crypto Voices Looking for Regulatory Clarity