ICO: FCA’s Regulatory Position
The Financial Conduct Authority (FCA) does not offer a universal criteria to determine whether an Initial Coin Offering (ICO) falls under its regulatory reach. According to the FCA, a this can be decided only on a case by case basis. As a result, a multitude of ICOs are not subject to the FCA’s clearance. However, due to a variance in structure, ICOs often involve regulated investments. At the same time, the firms which are a part of the ICO process may also be subject to regulation.
The UK Regulatory Position
ICO participants often see a lack of regulatory barriers as a primary attraction of carrying out the ICO in the UK. Whilst the ICO regulatory framework in the UK is non-existent (both the concept and its terminology), the perception that all ICOs are unregulated is a misconception.
Due to a consumer warning concerning ICOs, the FCA identified certain similarities between ICOs and IPOs in September 2017. Thus, crowdfunding, collective investment schemes, and private placement of securities were identified as facets of ICOs which fall under the existing legislation.
Authorisation of ICOs is subject to whether it involves activities falling under the regulated guidelines. These include dealing, arranging transactions, providing financial services or advisory services for the investment industry in the UK.
All regulation and categories are set out under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544).
Section 19 of the Financial Services and Markets Act 2000 (FSMA) sets a general prohibition:
a person may not carry on a regulated activity in the UK, or purport to do so, unless they are either an authorized person or an exempt person.
Thus, any person who seeks to carry out activities which are in breach of the general prohibition, as described in FSMA, are liable for prosecution that may lead to a maximum of two years in prison or a fine. Moreover, agreements may be made void if entered into by parties who act in breach of the general agreement or without the necessary permission. Failure to adhere to the general prohibitions could result in compensatory requirements to be paid out to investors who have purchased tokens.
Promoters of an ICO may require authentication depending on whether the offering will involve activities that are regulated: dealing, advising or arranging transactions, in the context of the UK commercial sector and in relation to specific investments. These categories of investments are outlined within the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544).
Below are some of the most frequently used specified investments within an ICO and the regulated activities that may be undertaken with regard to them:
- Collective investment schemes.
Collective investment schemes (CISs) are defined as specified investments as under section 235 of FSMA. They are, according to section 235, any arrangement with regard to property under any description, including money. The purpose of CISs is to enable participants to derive profits or income that is brought about by the CISs are specified investments and are defined in section 235 of FSMA as any arrangements with respect to acquisition, management, holding, or disposal of property or dividends thereof.
- Alternative Investment Fund. Alternative investment funds (AIF) are a collection of investment undertakings that serve to raise funds from a plural of investors. The purpose of AIFs is to allow investors to provide capital for a defined investment policy with the expectance of future dividends or economic gain. A token is subject to the AIF regulations depending if it engages in activities that fall under the general guidelines of FSMA.
- Electronic money. The tokens that are issued under the investment guidelines of an ICO may be considered as a form of electronic money. Electronic money may be defined under the following criteria:
- Provide the means of payment for certain transactions
- Accepted by any individual or legal entity, other than the token founder(s).
Issuing electronic money is regulated under the FSMA guidelines. However, utility tokens satisfy the aforementioned conditions, apart from the case where the tokens are issued as a refund for cryptocurrency payment.
Marketing of ICOs
There are restrictions of marketing an ICO, which must be well governed.
Section 21 of FSMA states clearly that “a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity unless the promotion has been made or approved by an authorized person or it is directed at a person who falls into one of the exempt categories of recipient and meets a series of tests.”
Misleading statements and impressions
With regards to specific investments, section 89 and section 90 of the Financial Services Act 2012 cover misleading statements and misleading impressions respectively. These apply to issued whitepapers and any other marketing endeavors partaken by the token issuers.
Furthermore, section 89 of the 2012 Act also states that
a token issuer will commit a criminal offence if it knowingly or recklessly makes a materially false or misleading statement, or dishonestly conceals any material facts, with the intention of inducing, or it is reckless as to whether it might induce, another person to enter into, or to refrain from entering into a relevant agreement, for example, an agreement to subscribe for tokens.
Moreover, section 90 of the 2012 Act provides the basis for prosecution:
whereby a token issuer will commit an offence if, among other things, it creates a false or misleading impression as to the market in, or the price or value of, a relevant investment in order to induce another person to acquire or subscribe for investments such as tokens.
Token issuers are required to remain attentive to the common law liabilities – even if the token does not fall under specific investment regulations. Thus, civil liability may come to the force in case of the misleading marketing materials, activities, or omissions. Any public material that contains misinformation or deceit, leads to criminal and civil liability for an offense deriving from deception or misrepresentation.