Depth: Tencent invests in Kik vs. SEC

App Kik, an instant messaging device supported by Tencent, raised $150 million in August 2017. A few weeks before that, the SEC (SEC) issued a guide saying that 1CO may constitute an illegal securities issue, so it is not surprising that Kik received one of the subpoenas sent to the encryption project last year.

But last November, the SEC informed Kik that it was considering a law enforcement action against Kik that violated US securities laws, which was a serious problem. Why is this important? It may reveal some information: To what extent do regulators are willing to extend existing laws to reach encryption projects?

There is very little accurate information available on the way the regulators actually work. I share them in the context of the government and technology industry: how the SEC investigation happened (all industries, not just the encryption industry), How network usage affects the conclusion of whether Kik's cryptocurrency is considered a security, and what happens next in the industry.

In December last year, Kik submitted a content that was essentially a legal brief. Often, the SEC will give people a chance to file a lawsuit before they act. But now, it’s not far from the SEC’s 180-day deadline for deciding whether to take enforcement action against Kik.

We are not investors in Kik, but the arguments that Kik has made in this process are interesting because they represent how the industry responds to emerging technologies, as it is not clear which regulations apply and how they are applied.

What did the SEC do and how did the case start?

As an independent agency within the federal government, the SEC's main functions are: protecting investors; maintaining a fair, orderly, and efficient market; and promoting capital formation. To achieve its goals, the SEC has enacted a set of regulations, and its law enforcement agencies have jurisdiction over US and overseas personnel and companies to ensure compliance with these regulations – at least if overseas behavior has a significant impact on the United States or takes significant steps. .

Most SEC investigations start with informal under inquiry or "MUI", and the SEC can start for no reason. They are initiated in a number of ways: sometimes they are externally initiated, such as complaints from investors or investors.

But they can also come from internal initiatives of law enforcement officials, usually because of media coverage or some internal data analysis projects. Or they can come from recommendations from other agencies or the SEC, such as the Compliance Inspection and Inspection Office, FINRA, State Securities Regulatory, Congress or Judicial or Financial.

The first step in MUI is to issue documents for documents, but unlike subpoenas, it is optional to follow these requests. In fact, in the MUI phase, the SEC staff has not yet obtained the subpoena. The only person who needs to hand over information is an entity registered with the SEC, such as a broker-dealer and a registered investment adviser.

Within a few months of launching the MUI, the SEC staff decided whether to proceed, and if they wanted to do so, the SEC management must approve a formal investigation order (rarely rejected). The real significance of this phase is that the SEC staff is now entitled to a subpoena – and can force investigations of documents and affidavits, or may obtain testimony from anyone else who might have access to the information.

Although the SEC's subpoena is not very popular, it is wrong to equate it with the final enforcement action. A subpoena is simply the way the SEC collects information (including from third parties), so it can decide whether to take further action.

The voucher recipient can request a copy of the formal investigation order at any time, but few people use or know that they are entitled to the investigation. These investigation orders did not provide much detail, but the contents of the investigation were disclosed. The SEC staff usually provide some attention in the discussion that follows.

If the SEC staff decides to investigate, they will want to be as strong as possible in case they eventually go to court. Therefore, they may issue additional subpoenas or interview more witnesses. A former SEC law enforcement director once called it "investigation lawsuit."

Wells process, Kik, arguing

If the SEC staff decides to take further action after reviewing the evidence, they usually provide a Welsh notice. This is basically a letter or phone call to let the subject know that the SEC has initially decided to recommend enforcement actions.

The idea here is to get participants involved in a round-trip – decide whether to submit a written statement to explain why they are not a particularly good target, or why the SEC may fail in the arguments of the case, or ask for a higher level Meeting, and so on.

A compelling Wells submission actually allows staff to reconsider the original planned enforcement actions, and it is estimated that this is about 20%. But there are two disadvantages to participating in the process: the Wells proposal may also help the SEC to try to resolve weaknesses in the case before it is determined to file a lawsuit; and the statement of the Wells proposal can also be used for the subject of future investigations.

Kik was involved in the Wells Process, but they made the commit reply public and let the SEC know that their company would bring the SEC to court.

This is unusual because the Wells process is usually private and the parties usually do not say to the SEC – instead, the parties usually say that no lawsuit should be filed. This is serious and puts more pressure on the SEC to decide whether to use Kik as a 1CO lead case, a test case that attempts a wide-ranging issue.

The arguments presented in this process are interesting because they represent how the entire industry handles an emerging technology, and it is unclear which regulations apply and how they apply.

I found that Kik's submission response was very compelling, especially from the perspective of people who have been observing and working with entrepreneurs for some time.

One thing I have learned over the years, especially in the work of federal judges, is that you can read the briefings of one party and think "this is the case, they obviously have won the argument of victory", and if you only read the other party's briefing And think "it doesn't matter, in fact, this person has the argument to win."

(Currently) We have not (see) the SEC's briefing to assess their arguments – if we appeal later, we will see it later.

But Kik is doing very well, they emphasize:

(1) Their cryptocurrency is a consumer product called “Kin” and its integration with Kik's millions of active users—that is, focus on usage; (2) they are trying to find alternatives to advertising-based monetized digital goods. And service records—thinking that this is a way of competing with “FAANG” companies; (3) their integrity and compliance efforts – completing KYC/AML and OFAC screening, taxing on token sales revenue, and their in some jurisdictions Self-restriction in the jurisdiction.

Is cryptocurrency really a security?

Kik proposed a straightforward and thorough statutory argument that all currencies are not subject to securities laws. Kik believes that since the government has said that cryptocurrencies are currencies, they cannot be regulated as securities… so the SEC must let go.

This statement is based on the definition of securities that exist in both the Trading Act and the Securities Act. Interestingly, the “transaction law” explicitly excludes currency in its definition of securities (the term “securities” refers to any notes, stocks, stocks, stocks…but not currencies) . However, the "Securities Law" does not include or exclude "currency" in its security definition.

Is the currency excluded from the legal scope? Kik's proposal does not address some important statutory building codes – rules of thumb that help courts determine the legal significance. You can hardly blame them because the SEC's argument for lack of jurisdiction over cryptocurrencies has little chance to go hand in hand with the SEC. So, really, Kik is just arguing that the SEC might put the arguments to the court on the road ahead.

The more interesting question is whether the cryptocurrency is legally a currency?

Whether the currency can become a security, the more interesting question is, is the cryptocurrency legally a currency? At first glance, the government seems to have difficulty saying that Kin is not a currency, given that some of its previous statements define cryptocurrency as "currency."

On the other hand, some courts consider “money” to refer to fiat money, which means that if it is provided in the form of repayment of debt, it must be accepted. Now, although Kin may be used, Kin is not a fiat currency. It is expected that the court should pay attention to the simple meaning of the word "currency" when solving this problem.

Where does the Howey test come in?

The more predictable argument that Kin is not a security belongs to the now familiar Howey test. The test shows that securities are considered to be securities if: (1) investment funds, (2) co-enterprises, and (3) profit expectations through the efforts of others.

Kik's best argument seems to be (2), there is no common enterprise between them and the Kin buyers. The court believes that simply selling something, rather than more promises, does not result in a common business. According to the public information I reviewed, in addition to the delivery of tokens, any contractual obligations of Kik to the buyer are not obvious.

Once the delivery takes place, Kin holders control their tokens and use them as they wish – whether it's buying items or other means. Kik created an open market that aims to achieve real communication between the participants, so Kik is not necessarily a participant in all transactions.

Then (3), the expectation of profit through the efforts of others? In his Wells response proposal, Kik tells a good story about consumer use because it is integrated with the communications platform, which has millions of users when it sells tokens.

Clearly, 20% of Kin buyers connect their wallets to Kik and buy everything from games to digital products and services. Some participants bought a price of only 9 cents at Kin, which seems to be “use” rather than “investment”.

If I am defending the case, I would like to know how many people have bought such a small amount of money because this is a strong evidence of "consumer use rather than investment." I will also collect statements from several purchasers of Kik to use it to specify how they use it.

The SEC may also have more evidence against this argument – as we know, they have interviewed dozens or hundreds of people who bought Kin for investment purposes only. Of the 10,000 Kin buyers, there are definitely two types of people: for investment and for use.

But the anecdotal evidence about why the buyer bought Kin was not related to the evidence that Kik led the buyer to expect. This is because case law is less concerned with the idea of ​​a particular buyer at the time, and more attention is paid to the seller's "providing or committing" to the buyer's content.

So the key is to blame Kik for what statements you can make before selling—a good example of how PR, marketing, and other corporate building functions really matter in many encryption projects.

The focus of the law is not on the idea of ​​the particular buyer at the time, but more on the content of the seller “providing or committing” the buyer.

Kik said that its main marketing message is focused on the use of Kin rather than Kin as an investment, which makes sense because the project is only effective when people actually use Kin. If this is true, the SEC will need to deal with some of these facts:

(1) 50% of token sales participants purchased less than $1,000 in Kin, which seems to be more in line with consumer use and investment purposes. (2) Kik's approach to building things encourages broad participation and prevents speculation, for example, limiting the amount of personal purchases to ensure that more participants use their networks. (3) It delays the sale of tokens to ensure that the functionality of the network is first ensured and that it is now available for the future.

(4) Since the sale of tokens, the use of Kin has increased.

Of course, we don't know what additional facts, documents, and witness statements the SEC has gained as part of its own investigation process. Is there an email or witness confirming the fact that it contradicts Kik's documents? Even the conference video is talking about the planned 1CO, just like the CEO. If the SEC wins the Howey test, then it is best to have more evidence in this regard.

What is next?


In a typical Wells process, many subjects choose to close the case , either because they know they will fail or because they believe that fighting the SEC will be costly and distracting, or because they don't want to work with the main regulators Fight and face tougher sanctions.

The facts are objectively bad – for example, the Equifax insider's email is about how he exercises all his options before the data breach is made public – the settlement may be correct. The vast majority of cases have been resolved, which is what the SEC knows and relies on, because if everyone chooses to file a lawsuit, there is simply not enough resources to solve all the cases.

Usually, the settlement is submitted as an executive order and takes effect automatically. It is not uncommon to bring a settlement in court. These settlement applications are reviewed by very few courts and are usually approved.

Kik told us in a response from Wells that it did not reconcile.

Therefore, if the parties do not settle – or the SEC is not convinced in the Wells process – the SEC staff recommends taking enforcement action. The reason I say "recommended" is because the SEC law enforcement agencies are unable to take action on their own. Most of the five members must vote to continue.

The law enforcement department wrote a memorandum to the committee, recommended action, attached the advice of the Wells proposal, and must be prepared to answer the commissioner's questions. Most of the votes are the same, but now there are only four members, so there may be split votes.

If the SEC staff recommends execution and has a 2-2 split vote, the enforcement action will not be possible. While this is a good result for Kik, it will leave the possibility of future enforcement actions against similar facts and will not provide meaningful guidance to the encryption industry.

In the case of a 3-1 vote, action will be taken, but we may also see disagreements – objections may have important signal effects, that is, a sincere disagreement with the public, Congress, and the facts or laws of the public.

What other potential results are there? The SEC staff can convince Kik's Wells to submit a reply saying that the case is not the best tool for taking action (based on public facts, which I personally think is not the case), so I chose not to recommend action.

The whole point of the Wells process is to make full use of the argument. Such results are a good result for Kik, as well as for the broader field of encryption, especially if the SEC's report provides previous reasoning.

In theory, the two-way settlement is another possibility, but given that the Kik statement will bring the fight to court, this seems unlikely – and unlike some startups, Kik has the financial resources to do so. Still, the settlement is not a good result here, as it leaves important legal issues that are unresolved.

The solution is not the law, only the court can tell us what the law is.

Why solve problems for entrepreneurs and other technicians working in emerging fields? Because the SEC has a strong influence on the drafting of the case for certain cases, these solutions will divide the "law" into black and white. The SEC's solution is not a law, only the court can tell us what the law is.

Therefore, if more courts weigh the securities law for content in the field of encryption, it may actually benefit the encryption industry and remove some regulatory uncertainty. After all, the case law of 1944 – developed for the company before the software age – and in 2019, what is the relevance of such a decentralized autonomous organization?

The Kik case is an early example of an interesting question in the field of cryptocurrency, and we will soon discover what the SEC's position is.

One of the most common misunderstandings I have heard is that "the SEC will let them wear prison uniforms." This is not true because the SEC can only file civil cases. But they can refer the issue to the Ministry of Justice, and sometimes these two institutions will bring parallel cases (such as Theranos).

However, this is rare because criminal cases require criminal intent and are subject to a higher burden of “exceeding evidence of reasonable doubt”. The SEC only needs to prove superiority evidence, which means that the SEC's statement does have a probability of more than 50%.

All of this is not to scare anyone to make something interesting! This is just to give entrepreneurs an understanding of the SEC's processes. So, in addition to observing how this particular situation works, what else can you do?

If you go to court, then we will see various projects, foundations, non-profit organizations and academics, by submitting amicus briefings and participating. “amicus” means a person who is not a party to the case but who has a strong interest in the subject. Such briefings have become commonplace, especially in important cases where new issues are raised, and a good set of amicus briefings is very convincing for judges.

But in addition to observing this situation, the best way to navigate the uncertain rules is to consider how the event should be treated. You always want to be able to prove your sincerity, common sense judgment and rationality. But when people can do this, they are unlikely to be the best (or winning) tool for the government, so you should look at everything from this perspective.


Author: Katie Haun

Translator's profile: Aile Bull , a special author of the Blockchain Learning Society.

Disclaimer: This article is the author's independent point of view, does not represent the position of the Blockchain Institute (Public Number), and does not constitute any investment advice or advice.