Ethics in Practice: Raising Capital with Digital Assets? Case for Week of 5 February
Analysis now posted. How did you do with this interesting case?
New currencies and ways to raise capital in this digital age are enticing and opening doors for some companies. But could using them raise any challenges or questions from an ethical or professional conduct standpoint?
Case
Munchee is a US-based business that created an iPhone application (App) for users to review restaurants. The company initiated an initial coin offering (ICO) to sell digital tokens to raise $15 million in capital to invest in improving the App. The company advertised and promoted the offering on its website, in a white paper, and on social medial channels and message boards, such as Twitter and Facebook, particularly in forums aimed at those interested in investing in Bitcoin and other digital assets. In the communications about the offering, Munchee said it would use the proceeds to create an “ecosystem” in which the company, its App users, restaurants, and others could use the tokens to buy and sell goods and services. Munchee explained that it expects the tokens to increase in value as a result of the company’s efforts. In addition, increased participation in the ecosystem and the use, or “burning,” of tokens would also help increase the value of the tokens. Finally, Munchee stated that it intended for the tokens to trade on a secondary market. Munchee’s ICO was
- unacceptable because it promoted a virtual and highly speculative investment unsuitable for investors.
- unacceptable because it promoted the investment through social media, blog posts, and brief tweets that did not describe the significant limitations and risks associated with buying the tokens.
- unacceptable because the tokens were an unregistered security under US securities laws.
- acceptable.
Analysis
This case involves Standard I(A): Knowledge of the Law, which requires CFA Institute members to “comply with all applicable laws, rules, and regulations . . . governing their professional activities.” The fact that that the tokens are a virtual currency, highly speculative, and thus unsuitable for many investors does not make it unethical for Munchee to offer them as investments. Munchee is not an investment adviser but an investment issuer. It would be up to investors and their advisers to determine whether an investment was suitable for their portfolio. Similarly, from an ethical standpoint, Munchee is free to promote the tokens in a variety of ways as long as the company provides full and complete information about the investment, responds to inquiries from potential investors, and does not provide any fraudulent or misleading information about the tokens. Munchee can direct those who see brief promotional material about the tokens on social media to the company’s white paper that presumably contains full and complete information about the tokens. Again, it would be up to an investment adviser, not the issuer, to describe the significant limitations and risks associated with buying the tokens from an investor’s perspective.
This case turns on whether the tokens are a security and thus need to be registered according to the US securities laws (US law would applicable because Munchee is a US-based company selling the products in the United States). In its 11 December 2017 cease-and-desist order against Munchee, the US SEC declared that the tokens were securities as defined by Section 2(a)(1) of the Securities Act and must be registered. According to the test applied by the SEC, a product is a security if it involves the investment of money in a common enterprise with a reasonable expectation of profits that are derived from the entrepreneurial or managerial efforts of others. Upon being contacted by the SEC, the company immediately canceled the sale and refunded the money of buyers who had bought tokens. Because of this prompt action and Munchee’s cooperation, the SEC imposed no additional sanctions. In this case, the best answer is C because Munchee is a US company that violated US Securities laws. The laws of another jurisdiction may not require registration of this type of virtual currency as a security. In that case, answer A could be appropriate.
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More About the Ethics in Practice Series
Just as you need to practice to become proficient at playing a musical instrument, public speaking, or playing a sport, practicing assessing and analyzing situations and making ethical decisions develops your ethical decision-making skills. To promote “ethical exercise,” we are excited to introduce Ethics in Practice.
Each week, we post a short vignette, drawn from real-world circumstances, regulatory cases, and CFA Institute Professional Conduct investigations, along with possible responses/actions. We then encourage you to assess the case through the lens of the Ethical Decision-Making Framework and the CFA Institute Code of Ethics and Standards of Professional Conduct and let us know which of the choices you believe is the right thing to do and why. If you are not a CFA Institute member, you can post your choice and reasoning in the comments section below. For CFA Institute members, we would like you to join the conversation in our new Member App and post your responses there. Later in the week, we will post an analysis of the case and you can see how your response compares.
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