Co-Founder & Trustee, BlockDevs Asia Inc.
Author, Fintech: Law & First Principles<
SEC’s Public Advisory against Lodicoin
Table of Contents.
On 29 September 2022, the Philippine Securities and Exchange Commission (SEC or “Commission”) issued a Public Advisory against what the Commission described as “unauthorized investment-taking activities” of Lodi Technologies Incorporated (doing business under the name and style/s of LODITECH) in relation to LodiCoins ($LODI). The advisory was prompted by information gathered by the SEC, where upon investigation LodiTech was found to be using social media platforms like Facebook, Twitter, Instagram and Discord to solicit investments for the sale of Lodicoins.
Lodicoin has been described by the team behind it as a “Binance Smart Chain-based utility token that will drive the transactions on the LodiApp. Users can participate in the Lodicoin ICO (initial coin offering) sale to buy the tokens. Post the ICO sale, Lodicoins will be available on the LodiApp, where they can be bought in exchange for other cryptocurrencies.”
The SEC noted that while a disclaimer in Lodicoin’s white paper stated that Lodicoins cannot and should not be considered as a share or security of any type, such statement did not have any legal bearing; in fact, its founder and Chief Executive Officer “hyped or shilled on Facebook that Lodicoin would be listed at ten times the pre-sale or original private price, making it appear that those who will purchase the coin in the ICO will earn at least 1000% in profits.” The disclaimer therefore lacked substance because in reality, LodiTech’s posts in social media promised that “investing in Lodicoin will give the investor an opportunity to earn through the virtual currency.”
Per SEC’s findings, LodiTech promised earnings for investors by acquiring Lodicoins on pre-sale and purchasing $LODI in advance through an initial coin offering (ICO) at a substantially low price under the pretext that the token will considerably appreciate in value once $LODI is officially launched and listed on crypto exchanges. Further, Lodicoins offered packages with inclusions such as bizarre commission rates as high as 54%. Depending on the packages purchased thru its Rank Bonus scheme, LodiTech additionally promised cash bonuses, car, luxury watch and travel incentives.
Even before the Advisory against Lodicoins, it has been made clear in a line of SEC advisories that depending on the relevant facts and circumstances surrounding their issuance or distribution, some cryptocurrencies or digital assets may be considered as security. When a digital asset has attributes of a security, said asset needs to be registered with the SEC before they can be offered publicly. Those who act as salesmen, brokers, dealers or agents in selling, distributing, or convincing people to invest in security tokens without license or authority from the SEC may be subject to criminal prosecution, as provided under Section 73 of the Securities Regulation Code (SRC).
The concept of “security” per Securities Regulation Code
Securities are shares, participation or interests in a corporation or in a commercial enterprise or profit-making venture and evidenced by a certificate, contract, instruments, whether written or electronic in character. By statutory definition, the term “security” includes:
- Shares of stock, bonds, debentures, notes, evidences of indebtedness, asset-backed securities;
- Investment contracts, certificates of interest or participation in a profit sharing agreement, certificates of deposit for a future subscription;
- Fractional undivided interests in oil, gas or other mineral rights;
- Derivatives like option and warrants;
- Certificates of assignments, certificates of participation, trust certificates, voting trust certificates or similar instruments;
- Proprietary or nonproprietary membership certificates in corporations; and
- Other instruments as may in the future be determined by the Commission.”
As a general rule, securities are not to be sold or offered for sale or distribution without due registration, and provided that information on the securities shall be made available to prospective purchasers. Included in the list of securities that require registration prior to offer, sale, or distribution are investment contracts. The strict regulation of securities in the Philippines is based on the principle that the strength of the capital markets depend on the investing public’s level of confidence in the system. The registration requirement is intended to ensure public access to material information concerning the public traded securities and is central to the Securities Regulation Code’s investor protection framework.
The Securities Regulation Code treats investment contracts as securities that have to be registered with the SEC before they can be distributed and sold:
Sec. 8. Requirement of Registration of Securities. 8.1. Securities shall not be sold or offered for sale or distribution within the Philippines, without registration statement duly filed with and approved by the Commission. Prior to such sale, information on the securities, in such form and with such substance as the Commission may prescribe, shall be made available to each prospective purchaser.
In determining whether a security is being offered publicly or privately, Rule 3.1.17 of the 2015 Implementing Rules and Regulations of the Securities Regulation Code define “Public Offering” as any “offering of securities to the public or to anyone, whether solicited or unsolicited.” Further, any “solicitation or presentation of securities for sale through any of the following modes shall be presumed to be a public offering:
- Publication in any newspaper, magazine or printed reading material which is distributed within the Philippines;
- Presentation in any public or commercial place;
- Advertisement or announcement on radio, television, telephone, electronic communications, information communication technology or other forms of communication; or
- Distribution and/or making available flyers, brochures or any offering material in a public or commercial place or to prospective purchasers through the postal system, information communication technology and other means of information distribution.”
Furthermore, the private placement exemption rule in the Philippines apply only to the “sale of securities by an issuer to fewer than twenty (20) persons in the Philippines during any twelve-month period.”
The SEC has authority to regulate the sale or trading of any new instruments that functions as a security. Section 3.1(g) of the Securities Regulation Code contains a catch-all provision on the definition of security:
“Other instruments as may in the future be determined by the Commission.”
This provision contains reserved power conferred upon the SEC to address future contingencies and circumstances, considering that the securities space is a fast evolving sphere and fraudulent actors have become sophisticated in their nefarious schemes. This is “designed to prevent evasion of promoters or issuers who may adopt ingenious schemes in order to escape regulation or registration.” Moreover, “with the advent of the internet and electronic access to information, new securities instruments that may be carried on by electronic impulses are expected to develop in addition to existing traditional securities. The flexibility of the definition recognizes financial market innovations worldwide.”
Notably, mere selling of securities without prior authority to do so already consummates the offense under the Securities Regulation Code considering that it is malum prohibitum, which means criminal intent (mens rea) is not relevant to successfully prosecute a violation of the SRC.
Investment contract as security
An investment contract is defined by Philippine case law as a “contract, transaction, or scheme where a person invests his money in a common enterprise and is led to expect profits primarily from the efforts of others.” The touchstone is the investment in a common venture arising from a reasonable expectation of profits on the part of the investor to be derived from the managerial or entrepreneurial efforts of the issuer. In Virata vs. Ng Wee, the Supreme Court observed that an investment contract “is presumed to exist whenever a person seeks to use the money or property of others on the promise of profits.” According to the interpretation of the Securities and Exchange Commission, later confirmed by the Supreme Court, a common enterprise is deemed created when two (2) or more investors “pool” their resources, even if the promoter receives nothing more than a broker’s commission.
The United States Federal Supreme Court had several occasions to discuss the nature of investment contracts. The U.S. court’s rulings, while not binding in the Philippines, enjoy some degree of persuasiveness insofar as they are logical and consistent with the Philippines’ best interests. This is due to the fact that the Philippine securities regime is patterned after the Federal securities law of the United States.
The U.S. Supreme Court held in Securities and Exchange Commission v. W.J. Howey Co. that in order for an investment contract to exist, the following elements must concur: (1) an investment of money; (2) investment is made in a common enterprise; (3) expectation of profits on the part of the investor; and (4) profits arising primarily from the efforts of others. As in the United States, Philippine jurisprudence also refers to this doctrine as the Howey Test.
The Howey Test “embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” In the Virata case cited above, the Philippine Supreme Court stated that the Howey case served as “the foundation for the domestic definition” of investment contract as a security. Further, in analyzing whether something is a security, substance must prevail over form; thus, the economic realities underlying a transaction should matter more than the name by which it is called by its issuer.
Applying the Howey Test, jurisprudence confirmed the SEC’s interpretation that the following schemes constitute investment contract which will require registration before they can be offered to the public: membership certificates sold by advertising or promising profit unusual in the ordinary course of business; “sans recourse” transactions where investors pool their resources to meet the financial needs of a borrowing company; soliciting investors to bear the cost of advertising the sale of products to be marketed in Japan through mail order sales system, with a promise of 30% of the sales revenue of products sold; fund management schemes; foreign exchange trading transaction; “Performance Managed Portfolio” for foreign currency trading; and “Statement of Private Business Affair” promising the investor three percent (3%) monthly interest for six (6) months.
SEC issuances relating to cryptocurrencies and initial coin offerings
Merely calling a digital asset a “utility” token or structuring the token to provide some utility does not prevent the token from being viewed as a financial instrument or a security. Tokens and offerings that incorporate investment features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others contain the hallmarks of a security under the Securities Regulation Code.
In 2017, the Philippine SEC started actively issuing advisories, notices to the public, Cease and Desist Order (CDO) and draft regulations that relate to cryptocurrencies, investment schemes and initial coin offerings (ICO). The first occasion was in the SEC’s Public Advisory of June 2017 against MONSPACE Philippines in relation to MSCOINS. SEC’s Public Advisory of October 2017 against PLUGGLE Inc. demonstrated that SEC will assert jurisdiction on unregistered investment schemes, whether the investment was paid in legal tender or in cryptocurrencies such as bitcoin.
In January 2018, the SEC issued its first Public Advisory about Initial Coin Offerings (ICO). ICO was then understood by the SEC as the “first sale and issuance of a new digital token to the public usually for the purpose of raising capital for start-up companies or funding independent projects.” According to the SEC, digital tokens depending on the relevant facts and circumstances surrounding their issuance, may be considered a security. When a digital token has attributes of a security, said token needs to be registered with the SEC before they can be offered publicly. Within the same month, the Philippine SEC issued for the first time a Cease and Desist Order (CDO) directed against an ICO. The CDO enjoined Black Cell Technology Inc., Black Cell Technology Limited (a Hong Kong limited liability company) and collectively the KROPS ICO from engaging in the sale or offering for sale of KROPS Tokens (also known as KropCoins) until the requisite registration statement is duly filed with and approved by the SEC. In the said administrative case, the SEC ruled that KROPS Tokens satisfy the Howey Test for the following reasons:
- “Money” in the Howey Test refers to any valuable consideration, as was highlighted in the Decentralized Autonomous Organization (DAO) Report (by) the U.S. SEC dated July 25, 2017.
- Common enterprise is evident from the alleged “2,347,985 tokens sold” that there are multiple investors.
- It was claimed that KROPS’ primary value driver is its market share or the value of its transactions it can capture on its marketplace. Investors are led to expect that their investment in KROPS Tokens will appreciate.
- The increase in value of the KROPS Tokens and the KROPS profit-making venture does not depend on the efforts of the investor. “Investors need not participate in the envisioned agricultural marketplace, e.g., as buyer or seller.”
In the KROPS CDO, the SEC also had the occasion to clarify that offering for the sale of a digital token through a dedicated website accessible in the Philippines constitutes public offering.
The Philippine SEC also issued a Public Advisory concerning Cloud Mining Contracts. “Cloud mining” was understood as a process of acquiring cryptocurrency through the utilization of shared mining equipment located in an off-site or a remote data center, with the purchase of equipment being funded by investors who avail of cloud mining contracts. Applying Howey Test, the SEC advised that a cloud mining arrangement is an investment contract falling within the purview of the term “securities” as defined by the Securities Regulation Code; those who act as salesmen, brokers, dealers or agents in selling or convincing people to invest in cloud mining without license or authority from SEC may also be criminally prosecuted.
In 2020, the SEC issued an Advisory and warned the public against BLOCKXPERTS, INC.’s CRYPTOPESO scheme and “PHPc Staking Program.” The scheme required the investment of at least PHP2,000.00 from its members plus the activation fee in the amount of PHP500.00. The amount invested will be converted into Cryptopeso (PHPc), which will be staked and locked in for three, six, 12, or 24 months, at the option of the investor. After “staking” the money, members can no longer use and convert it into Peso because if they do before the end of the locking period, they will be penalized by deducting the 7% of the total amount they invested. In explaining why the scheme is considered an investment contract, the SEC noted:
“It is evident that the scheme offered by CRYPTOPESO is a security in the form of an investment contract. First, it involves an investment of money because the member is required to stake his money for a certain period. Second, there is an investment in a common enterprise because the party soliciting investments pays out profits from its pooled funds. Third, there is the expectation of profits because the investor is given the promise of returns in the form of cryptocurrency which can be converted into Peso after the lock-in period. Lastly, the profits are generated from the efforts of others because CRYPTOPESO and its operator undertakes to perform all the profit-generating activities like Bitcoin mining, and distributes profit shares in accordance with a scheme that they designed and fully control.”
Subsequent to the public advisory against CRYPTOPESO, the SEC issued an advisory, which was followed by a cease and desist order, against FORSAGE for enabling unregistered securities to be offered in the Philippines. According to the SEC, FORSAGE’s smart contract-enabled “Crypto Earning Program” partakes of the nature of securities where investors do not need to actively exert effort other than to passively invest or place money in its scheme to earn profit. The SEC also characterized FORSAGE as “Ponzi Scheme where monies from new investors are used in paying ‘fake profits’ to prior investors and is designed mainly to favor its top recruiters and prior risk takers.” The fact that FORSAGE claims to be a decentralized platform that runs through the use of smart contracts did not matter in the SEC’s “investment contract” analysis.
SEC’s “investment contract” analysis as applied to Lodicoin
The Philippine SEC gave a nod on the U.S. SEC’s 2017 The DAO Report, confirming the possibility that existing securities law may apply even to blockchain-related activities “without regard to the form of the organization or technology used to effectuate a particular offer or sale.” Depending on specific facts and circumstance, some cryptocurrencies should be legally treated as securities, particularly an investment contract. Their designation as “currency” has no legal bearing when in fact they essentially behave like securities, which must be subject to prior registration before they can be offered to the investing public. The Philippine SEC further explained:
“The same goes for LODICOIN where Lodi Technologies Incorporated seeks to use the money it gathered from the public to fund its purported project on the promise of profits. Applying the Howey Test, the investment-taking scheme employed by Lodi Technologies Incorporated is an investment contract as it involves the offering and sale of securities to the public where their investors need not exert any effort other than to invest or place money in its scheme with the expectation of profits.
Hence, no matter how LODICOIN portrays itself as ‘utility token,’ clearly, $LODI is being offered for its potential for price appreciation, not to mention profit opportunities through commissions, bonuses and other incentives. In this case, the sales materials and literature describe LODICOIN as having profit potential (in the words of the CEO – ‘we will list at ten times more than the pre-sale price’), and therefore, it is offered in such a way that the investor ‘expects profits,’ as to ultimately, consider it as a security.
In other words, merely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security. Tokens and offerings that incorporates features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others contain the hallmarks of a security.”
The Securities Regulation Code does not apply solely to the obvious, common and traditional forms of securities. New, innovative and unorthodox schemes, whatever their form, also fall within the SEC’s regulatory perimeter if as a matter of fact they were publicly offered under such terms that would characterize them as an investment contract or security. Indeed, the law was enacted to regulate securities, in whatever form they are made and by whatever name they are called.
LodiTech claimed that “the use of Lodicoin for transactions will increase its utility, which will eventually contribute to its popularity and price in the future.” LodiTech also led investors to reasonably expect that the entrepreneurial and managerial efforts of its founders would drive the success or failure of Lodicoin. By offering Lodicoins in the Philippines through an initial coin offering, Loditech facilitated $LODI’s distribution in the Philippines and therefore exposed Philippine residents from unwarranted risks associated with an unregistered security.
The SEC’s Advisory against Lodicoin demonstrates how first principles of securities law apply to new paradigms in financial technology, such as when projects use blockchain technology to facilitate capital formation activities, investments and the public offer or sale of new types of securities. The automation of certain functions through blockchain and smart contracts does not remove the above activities from the material scope of securities law. This means that the registration requirements under the Securities Regulation Code apply with equal force with respect to new products and platforms that employ emerging technologies to provide unconventional investor interfaces.
This article is published on BitPinas: Lodicoin, Meet Securities Law
The SEC Advisory was dated 27 September 2022, although it was published on SEC’s website on 29 September 2022 and became publicly accessible in the morning of 30 September 2022. (https://www.sec.gov.ph/advisories-2022/lodicoins/) ↑
SEC Advisory dated 27 September 2022, p. 1. ↑
Id., p. 2. ↑
Id., p. 2-3. ↑
Id., p. 3. ↑
Id., p. 4. ↑
Section 3.1, Securities Regulation Code (R.A. No. 8799 ) ↑
Power Homes Unlimited Corp. v. Securities and Exchange Commission, G.R. No. 164182 (2008). ↑
This makes the “reverse solicitation doctrine” (recognized in some jurisdictions) not applicable in the Philippines. ↑
Section 10 (K), Securities Regulation Code of 2000. ↑
Atty. Lucila Decasa, Securities Regulation Code Annotated (2013). ↑
Puerto v. People, G.R. No. 236564 (Notice) (2018). ↑
Securities and Exchange Commission v. Prosperity.com, Inc., G.R. No. 164197, (2012). ↑
People v. Petralba, G.R. No. 137512 (2004) ↑
Virata v. Ng Wee, G.R. Nos. 220926 (2017). ↑
Securities and Exchange Commission v. Santos, G.R. No. 195542 (2014). ↑
Power Homes Unlimited Corp. v. SEC, G.R. No. 164182 (2008). ↑
Tcherepnin v. Knight, 389 U.S. 332, 336 (1967); United Housing Found., Inc. v. Forman, 421 U.S. 837, 849 (1975). ↑
People v. Fernandez, G.R. No. 45655 (1938). ↑
Virata vs. Ng Wee, supra. ↑
Securities and Exchange Commission v. G. Cosmos Philippines, Inc., G.R. No. 167435 (Notice) (2015). ↑
See Philippine Deposit Insurance Corp. v. Gidwani, G.R. No. 234616 (2018) ↑
People v. Petralba, G.R. No. 137512, September 27, 2004. “When the investor is relatively uninformed and turns over his money to others, essentially depending upon their representations and their honesty and skill in managing it, the transaction generally is considered to be an investment contract.” ↑
Securities and Exchange Commission v. Santos, G.R. No. 195542 (2014). ↑
Puerto v. People, G.R. No. 236564 (Notice) (2018). ↑
Rafael Angelo M. Padilla, Fintech: Law and First Principles, Rex Book Store, p. 86 (2020). ↑
Part of the Marketing Plan for MSCoins is to entice the public to join by investing an initial capital of Seven Thousand Six hundred pesos (P7,600.00), Eight Hundred Pesos (P800.00) representing Registration Fee
and Six Thousand Eight Hundred pesos (P6,800.00) for 500 Product Points, respectively. See: http://www.sec.gov.ph/wp-content/uploads/2017/06/2017Advisory_MonspacePhilsAdvisory.pdf ↑
See: http://www.sec.gov.ph/wp-content/uploads/2018/01/2017Advisory_InitialCoinOffering.pdf (posted on 08 January 2018); This definition would later be expanded in SEC’s proposed Regulation for Initial Coin Offerings to cover any “distributed ledger technology fundraising operations involving the issuance of tokens in return for cash, other cryptocurrencies or other assets. They involve coins (‘or tokens’) being issued in order to raise money from the general public in return for cash, other cryptocurrencies or other assets. Once the project reaches a certain stage, benefits to tokenholders may include, but is not limited to, any of the following: (a) gains through profits or increase in the value of tokens which can be sold if the project is successful; (b) voting or governance rights; or (c) usage rights. Initial Coin Offerings shall include follow-on offerings or issuances of tokens”. From this broader definition, it can be inferred that for legal purposes, ICOs is synonymous to what is known in industry jargon as Securities Token Offering (STO), token launches, Token Generation Event (TGE), direct token sale and Initial Exchange Offering (IEO). ↑
In 2018, the SEC proposed the regulation of ICOs that would offer a regulatory path for security tokens to be legally registered according to established Philippine securities law. The Philippine SEC recognized that there is a distinction between utility tokens and security tokens. As far as security tokens are concerned, the SEC attempts to recast traditional securities law and principles to enable regulation to adapt and potently deal with ICOs. The proposed regulation recognizes that Initial Coin Offerings could help raise capital and resources for small and local businesses start-ups or ventures, according to regulatory standards and that it is essential to ensure that ICOs operate in a manner that is consistent with investor protection, and in the interest of the public, market integrity and transparency. According to the proposed rules, the first step is for the token issuer to submit an Initial Assessment Request that will afford the SEC the opportunity to evaluate the features and the functions of the token and assess whether it is a security that will require prior registration before they can be offered to the retail market. As of this writing, the proposed regulation has not yet been finally approved by the Commission. ↑
See: https://www.sec.gov.ph/wp-content/uploads/2018/01/2018CDO_BlackCellTechnology.pdf; See also SEC Resolution dated 02 March 2018 on KROPS’ Motion to Lift CDO: https://www.sec.gov.ph/wp-content/uploads/2018/03/2018Resolution_BlackCellTechnology.pdf ↑
(posted on 10 April 2018); See also SEC Advisory on AirBit Club that soliciting unregistered cloud mining contracts: http://www.sec.gov.ph/wp-content/uploads/2018/09/2018Advisory_AIRBIT_CLUB.pdf
(04 September 2018). ↑
The term “staking”, as understood in the context of blockchain consensus protocols, was misused by Blockxperts, Inc. to mislead and entice investors who might not have the sophistication to understand how blockchains work. ↑
See http://www.sec.gov.ph/wp-content/uploads/2020/04/2020Advisory_CRYPTOPESO_07042020.pdf (Posted on 07 April 2020) ↑
See http://www.sec.gov.ph/wp-content/uploads/2020/06/2020Advisory_FORSAGE.pdf (Posted on 30 June 2020). ↑
SEC Advisory dated 27 September 2022, p. 5. ↑
Rafael Angelo M. Padilla, Fintech: Law and First Principles, Rex Book Store, p. 85 (2020). ↑
U.S. SEC, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Release No. 81207 / July 25, 2017 (p.2) ↑