SEC Is Set to Monitor Digital Coin Sales as Market Tops $2 BillionBy and
ParagonCoin hopes to raise $60 million in ICO on Sept. 15
Startup going newfangled route because ‘it’s the future’
Jessica VerSteeg answered the phone and apologized for her voice. She was hoarse following a series of interviews to promote her marijuana startup, Paragon, which hopes to raise $60 million starting Friday to fund its plan to become the WeWork of pot.
The former model turned chief executive officer skipped the traditional fundraising route. Instead of an initial public offering of shares, VerSteeg is going with a very 2017 idea: an initial coin offering, selling digital tokens dubbed ParagonCoin that cannabis firms or nonprofits would use to pay rent at the company’s planned co-working spaces, to be located where marijuana is legal. A successful deal will add to more than $2 billion raised by companies this year through ICOs, according to financial analysts at Autonomous Research LLC.
Leading up to the sale, the 30-year-old blanketed social media, posing on Instagram with the rapper The Game. On Twitter, she suggested that the cash found in a pair of jeans could buy some of her digital currency. On the company’s Facebook page, VerSteeg posted updates on the presale of coins, which sold out -- all in service to getting people to pay attention.
Also paying attention: regulators in Washington tasked with preventing investors from getting fleeced as ICO fever sweeps the country. The U.S. Securities and Exchange Commission warned the industry in July that if these tokens are effectively securities such as stocks or bonds, they must be registered with the regulator.
Following the News
The SEC is now monitoring the ParagonCoin deal and other pending ICOs to see whether they’re breaking that rule, according to a person familiar with the matter. Since many ICOs, including Paragon, are not registered with the regulator, the agency is keeping an eye on the market by following news reports on them, the person said. ParagonCoin hasn’t been accused of wrongdoing or triggered any SEC action.
“Our token’s not a security, it’s a utility,” she said in an interview. In addition to being used to pay, the coins will grant holders the right to vote on changes to how Paragon runs its business or to present ideas for how it could evolve, she said.
“The SEC is doing their job, they’re really trying to find the people breaking the rules,” VerSteeg said. “I’m actually thankful for them. I think to be scared of them means you’re doing something wrong.”
Any SEC enforcement action would hinge on the definition of a security. Under federal law, a security is typically created when investors provide money that funds a company with the intention of profiting from that company’s management. For example, when a jewelry store lends a customer money to buy a ring, that loan isn’t considered a security because the purpose is to increase sales. But if the company raises money through a stock sale to extend credit, that’s considered a security.
Paragon bills itself as “revolutionizing all things cannabis with blockchain.” True to that mission, forget your U.S. dollars or euros. To pay rent, hire in-house legal aid or buy a doughnut at the Paragon commissary, you must use the company’s digital coins. “If we could raise at least $60 million, it would be good enough to build one or two work spaces,” VerSteeg said, referring to its ParagonSpace co-working spaces. “We’re a tech company with a real estate side to it.”
Before creating ParagonCoin with her husband, Russian entrepreneur Egor Lavrov, she founded pot delivery service AuBox, which brought medical marijuana products to patients’ homes. She won the Miss Iowa United States competition in 2014.
“It’s good to have these regulations because there’s so much going on,” said VerSteeg, who added the SEC hasn’t been in touch with her company. Scammers engaged in pump-and-dump schemes related to ICOs need to be stopped, she said. “Regulation will weed out some of that.”
ParagonCoin promoter The Game is far from the only celebrity to endorse an ICO. Former championship boxer Floyd Mayweather promoted Stox, a digital coin linked to a prediction market. Paris Hilton, the celebrity famous for being famous, used her Twitter feed on Sept. 3 to promote LydianCoin, a digital token that says it’s linked to the “first A.I. big data marketing cloud for blockchain.”
Almost from their inception, ICOs have been ripe for abuse. As much as 10 percent of the money investors have given this year to ICOs was instead stolen through phishing scams, in which thieves convince people to send money to Internet addresses that aren’t in fact linked to digital token offerings, according to a study by Chainalysis, a blockchain transaction verification company based in New York.
The SEC warned individual investors on Aug. 28 of the risks in buying the tokens, cautioning that scammers are using the new fad to lure investors into old manipulation schemes such as penny-stock pump-and-dump scams. Other governments are paying attention too. China’s central bank said Sept. 4 that ICOs are illegal.
For the moment, ICOs are largely a buyer-beware market, with many issuers cloaked in secrecy. ExioCoin, which had raised less than $500 as of Sept. 12, claimed it had won the backing of a sovereign nation, which it didn’t name, and said it couldn’t disclose the identities of the development team “in order to preserve the integrity of the Foundation and the Exio principles.”
The LinkedIn profiles of Exio co-founders Marcus Knight and Sunny Johnson, which said they graduated from Oxford University, have recently been deleted. The school said it has no record of either having completed a degree in the subjects they listed, which include astrophysics or theoretical and mathematical physics. Knight said he was a trader at both Goldman Sachs Group Inc. and BlackRock Inc. Both companies said no one by that name worked there during the years Knight listed on his page.
As for Johnson, representatives from Barclays Plc and Facebook Inc. said he never worked for them as it stated on his LinkedIn profile. As of Sept. 13, ExioCoin said on its webpage that it was withdrawing its ICO because it “is unlikely to meet the crowdfunding target” and that all buyers of the coin “will be eligible to have their contributions returned.”
Knight and Johnson didn’t return email messages seeking comment.
Pump And Dump
Some fraudsters are selling interests in the currencies through dormant companies. These corporate shells are often used in pump-and-dump schemes, the same fraud that made millions for Leonardo DiCaprio’s character in the film “Wolf of Wall Street.”
“It is relatively easy for anyone to use blockchain technology to create an ICO that looks impressive, even though it might actually be a scam,” the SEC said in its August statement.
That same month, the SEC suspended trading of three companies that failed to provide required regulatory filings. One of the companies, First Bitcoin Capital Corp., had a market value of more than $800 million on Aug. 14 before the SEC halted trading. The company sells a variety of digital currencies, including the President Trump coin and TeslaCoilCoin, which has no affiliation with the electric carmaker.
“Clearly there’s going to be some government action in the ICO space,” said Kathryn Haun, a former federal prosecutor who handled cryptocurrency cases for the Department of Justice. “There are plenty of cases to choose from.” The SEC, Justice Department and the U.S. Treasury’s Financial Crimes Enforcement Network will all likely get involved, she said. “What we can expect to see is the opening of criminal investigations as well as SEC enforcement actions, maybe even in conjunction with each other.” ICO issuers also have to worry about potential class action lawsuits filed by token buyers who feel they’ve been defrauded, Haun said.
There are two categories of ICOs that government attorneys will likely focus on, Haun said. The first are cases of clear fraud where there was never any intention to build anything with the proceeds. The second is any unregistered ICO that raises a large amount of money after the SEC’s July pronouncement, because enforcement in such situations would have the largest deterrent effect, she said.
Haun is a fan of this new funding mechanism in many instances, but said that issuers still need to follow the law. The government will likely take time to bring actions, particularly in the second category, “because it will be a matter of first impression and the government doesn’t want to bring any case or action that isn’t rock solid or where there’s much gray area.” Haun, who is now a board member of the digital-currency exchange Coinbase Inc., was one of two assistant U.S. Attorneys who in January indicted a Russian national for allegedly laundering more than $4 billion using bitcoin.
VerSteeg’s difficulty in obtaining a bank account associated with AuBox -- her customers had to pay in cash -- led her to the idea of a cryptocurrency for medical marijuana. AuBox is no longer active, and unlike her former company, Paragon doesn’t handle any marijuana itself, she said.
VerSteeg also wants to unify a disjointed yet growing industry. But why leverage blockchain technology instead of creating a traditional startup? “It’s the future,” she said. “Why would I want to go back to an old Excel spreadsheet that can be tampered with?” The public ledger that backs Paragon will also provide total transparency to government regulators in both financial and drug-enforcement areas, she said.
“I want to set the bar high,” she said. “This industry deserves more respect. It’s medicine.”
— With assistance by Benjamin Bain, Alan Katz, and Sarah Frier