Beware of “Casually” Endorsing ICOs For Profit

Celebrities and ICOs Endorsements

Long story short: Paris Hilton, Floyd Mayweather, and a rapper nicknamed “the Game” touted a few ICOs of, euphemistically speaking, questionable quality. A few months thereafter, the Securities Exchange Commission (SEC) issued a general statement warning investors against following token recommendations from celebrities. The SEC pointed out that standard securities laws apply to sales of tokens which meet the definition of securities.

The SEC further stated that “celebrity endorsements may appear unbiased, but instead may be part of a paid promotion” and “Celebrities who endorse an investment often do not have sufficient expertise to ensure that the investment is appropriate (…)”. The full text of the SEC statement is available here.

The issue has been all over the industry media, but I have not seen any detailed examination of the facts, or discussion of potential repercussions for the trendsetters involved, or how the drama fits into the bigger picture of celebrities endorsing ICOs to come.

What Can Go Wrong When Paris Hilton Recommends an ICO

Frankly speaking, one has to stop and admire the ludicrousness of the case at hand. Celebrities who have no history of being intellectual powerhouses suddenly became cryptocurrency savvy, and the followers, well, followed. Unfortunately, as will be explained later in more detail, it is probably illegal to accept compensation for advertising an ICO and present it to your followers as a candid and spontaneous recommendation.

This is what Paris Hilton’s endorsement looked like, posted on September 3, 2017.

“Looking forward to participating in the new @LydianCoinLtd Token!  #ThisIsNotAnAd#CryptoCurrency #BitCoin #ETH #BlockChain”

— Paris Hilton (@ParisHilton)

My attention was immediately drawn to the first hashtag – #ThisIsNotAnAd. Cannot help but wonder, if Paris came up with this caveat herself, or one of her attorney friends warned her about the risks of endorsing ICOs, and this is how she applied the advice. Either way, it obviously has little to no legal significance. In fact, it could be an implicating statement, proving that, if she had in fact received payment for the endorsement, she was conscious of her disclosure obligations under securities law.

The crucial matter is whether she in fact received compensation for the tweet. Maybe she in fact spontaneously endorsed LydianCoin free of charge, and become a cryptocurrency enthusiast. I took one for the team and browsed Paris’ twitter a bit for any clues. I found no traces of any interest in cryptocurrencies, or any new technologies. The general content of the feed can basically be summarized in this tweet. Still, it doesn’t prove anything; but one cannot help but wonder.

As for LydianCoin, if the information on the company’s website is true, it’s doing quite well in its pre-ICO private sales. However, a little quick research shows that there are multiple reasons to be concerned, and Paris has apparently distanced herself from the company.

Of course, Paris has already deleted the post. Regardless of the reasons, the message surely got across to millions of people, and we will see how the story unfolds.

Mayweather has posted multiple tweets endorsing ICOs, see two of them here, and here. The hashtag “ad” on the former tweet gives away that it was not a spontaneous endorsement. Unfortunately, the tag is short, and kept out of sight by placing it at the very end of the tweet. In case of any legal repercussions, it will have to be determined whether it satisfies the disclosure requirements. In any case, the latter tweet does not mention the paid character of the tweet, thus we are left wondering whether the boxer has become a fan of blockchain-based technologies in the meantime, or whether one of his attorneys got slack and forgot to mark the tweet with appropriate disclosures.

For further entertainment, see for yourself the cryptocurrency endorsements of “the Game” (aka Black Jesus) here.

Entertained? The tweets have not been brought up solely for our enjoyment, as they also serve as a great backdrop for the analysis of the legal aspects of endorsing ICOs via social media.

The Legal Aspects of Celebrities Endorsing ICOs

Below I briefly analyze the legal standards for trendsetters endorsing ICOs, and the potential sanctions for those who violate them.

Legal Standard

The focal points in the current situation are SEC rule 10b-5, Section 17(a) of the 1933 Securities Act, and whether the tokens in question can be considered securities under Section 2(a)(1) of the 1933 Securities Act.

Without getting into too much detail, both rule 10b-5 and Section 17(a) are similar in that they prohibit and penalize fraudulent and deceptive practices in connection with purchase or sale of any security. They also forbid (i) making any untrue statement of a material fact, or (ii) omitting to state a material fact necessary to make the statements made (…) not misleading. The main difference between them is that Section 17(a) has a more stringent standard, given that it penalizes not only intentional, but also negligent behavior; however, only the SEC may use it as a ground for taking action.

In the aforementioned examples, all of the celebrities may have issued misleading statements. Based on a quick look at their profile, and taking into consideration their areas of interest, it is plausible that they were paid to endorse the coin sale, and make favorable statements regarding the coins. Even in the event it is true, there is nothing wrong with that in itself. However, they may be held responsible if they omitted to clearly mention that fact to their followers.

Their statements could be considered misleading because they made the public assume that they genuinely believe in the value of coins offered and their investment potential. Therefore, even in the absence of an intentional deceit or fraud, the celebrities may still be liable under rule 10b-5 and Section 17(a) if they in fact obtained money or property (e.g. coins) for the endorsement.

As for the definition of a security. This is one of those instances where a legal topic stops making people yawn and sends a cold shiver down their spine. Section 17(a) and rule 10b-5 apply only if a token sold via the ICOs in question can be considered a security.

The definition of a security listed in Section 2(a)(1) of the Securities Act of 1933 provides a long list of legal instruments. None of them really matches the characteristics of a token but one – “investment contract”, which could be used as a kind of catch-all clause. What is an investment contract? Suffice it to say that the definition was provided by the US Supreme Court in SEC v. W.J. Howey Co, and its application to tokens is still a heavily debated topic. You may want to read the recent SEC investigation report on the character of DAO tokens, available here, as it may cast some light on the issue. 

Sanctions

Generally speaking, Both the SEC and the purchasers of the endorsed coins could theoretically sue the endorser for damages. Additionally, in certain cases the SEC can seek fines of up to $5,000,000, and/or imprisonment.

It is actually hard to decide which is more scary: prosecution by the SEC, or a lawsuit by followers. Trendsetters have millions of subscribers, and it would be pretty easy to find and organize plaintiffs for a class lawsuit, especially given how attractive the celebs are as a lawsuit target. Of course, assuming breach of rule 105-b or Section 17(a) by the celebrities, the plaintiffs would still have to show, among others things, that they invested in the coins in reliance on the celebrities’ endorsement, and that the omitted fact of received compensation, was important in deciding whether to invest or not.

The Aftermath

The entire situation is comical, but worrying, because the three celebrities have around 26 million twitter followers combined. We will see how the case evolves, and whether we are going to see a class lawsuit pop up within a year or two.

Everyone hoping for a cessation in ICO regulation, may be in for a rude awakening. If people are gullible enough to follow investment advice from the “Black Jesus”, Paris Hilton and a boxer, we may expect the SEC to rain down heavily on ICOs, and crowdfunding in general.

Playing the fortune teller, I think that we will see one or two waves of legally sloppy celebrity endorsements which will get mowed down by the SEC and investor-followers before everybody gets the memo.

Feel free to comment and share.

Disclaimer

It should be emphasized that, to my knowledge, there is no action pending against any of the aforementioned celebrities. Furthermore, they should be given full benefit of the doubt until proven otherwise. This post is a hypothetical analysis of their tweets for educational purposes.