Kik knew it could get in trouble with $100 million ICO, the SEC says

Both Kik and the US Securities and Exchange Commission on March 20 filed a motion for summary judgment—a way to end their ongoing court case without going to trial. 

But according to two lawyers Decrypt spoke to, Kik doesn’t have much of a case. Marc Boiron, partner at law firm FisherBroyles, called Kik’s arguments “farfetched.” Crypto lawyer Gabriel Shapiro, who runs his own practice, called them “very weak.”

Why is the SEC suing Kik?

The battle concerns the $100 million initial coin offering (ICO) for Kin, the cryptocurrency network formerly connected to Kik, which is best known for developing its eponymous messenger app with hundreds of millions of users. 

Kik started Kin as a way to monetize its messenger app. It held a token sale in 2017 to jumpstart the Kin economy, Kik claimed in its filing.

The case centers around the application of the Howey Test, the general rule the SEC uses to determine whether an asset is a security. Essentially, if an ICO constitutes an investment contract, then it also constitutes a security under US law. 

All securities sales in the US have to be registered with the SEC. Kik didn’t register, so the SEC alleges that the ICO for Kin was illegal because it constituted an unregistered securities sale. 

Kik, on the other hand, maintains that the ICO wasn’t a securities sale because Kin isn’t a security. “Kik promoted Kin as a medium of exchange to be used in a new digital economy, not as an investment opportunity,” it wrote in its filing.

It points to the Terms of Use, which “constitute the entire agreement” between Kik and purchasers of the Kin tokens: notably, that Kik’s only obligation to users was to deliver tokens, and that tokens are to be used for the Kin ecosystem—they’re not an investment opportunity.

The court case has nearly bankrupted Kik, which has since fired over 80% of its staff and sold off its messenger app. A spokesperson for the Kin Foundation—the non-profit that maintains the network—told Decrypt that it has spent $6 million on the case so far. 

Was profit expected?

The SEC insists that Kin’s investors clearly expected profit—and the company encouraged it—which is another characteristic of a securities sale. "Investors bought Kin in such large quantities that their purchases only can only be logically explained by an expectation of profits," the regulator wrote in its filing.

Some investors bought Kin at a 30% discount compared to the public sale price, which gave them an obvious profit opportunity, the filing adds. According to Shapiro, this argument alone may be sufficient to establish a reasonable expectation of profits.

“Reasonable expectation of profits is one element of the Howey test and the facts cited are evidence that the buyers' of Kin had a reasonable expectation of profit. Whether Kin might also be useful for something is not really an issue,” Shapiro said.

Boiron told Decrypt that “Kik wants the court to focus on the language in the Terms of Use themselves rather than what any buyer intended.”

“Kik wants the court to ignore damning language in promotional materials,” he said, that “likely shows Kik’s state of mind and evidences the types of conversations Kik was having privately.”

The SEC, for instance, refers to May 25, 2017, when Kik CEO Ted Livingston appeared on CNBC and said investors would “creat[e] a place where they can create value for each other transacting in a new cryptocurrency. And that alone is enough to make a great financial return.”

Kik’s defense is that Kin token is a currency and not an “investment contract,” which would mean it would have not to be registered with the regulator. Kik also said that the latter term itself is “unconstitutionally vague,” implying that it didn’t know whether it might apply due to lack of clear advice.

The SEC’s latest filing refutes this. The regulator argued that Kik raised with its insurance broker that very risk—whether Kik’s token sale would not constitute a securities sale under the Howey test, a decades-old yardstick that the SEC uses to determine whether something is a security. 

It claims that Kik was seeking $10 million in additional insurance for officers and directors for legal defense costs.

“Kik for months considered—and actively planned for—the potential application of Howey to the Kin offering. Kik received explicit warnings in a report from its consultant that regulators could find that the offer and sale of Kin would be an offer and sale of securities,” the SEC’s document reads.

Speaking to Decrypt, crypto lawyer Gabriel Shapiro said this is one of the strongest parts of the SEC’s argument—and perhaps the one that will decide the final outcome of the case.

“Kik's affirmative defense is that the term ‘investment contract’ is so vague that Kik lacked notice it might apply,” said Shapiro. “The fact that it took out insurance to cover the risks shows that it was far from lacking notice—one among many reasons why ‘investment contract’ is not unconstitutionally vague,” Shapiro told Decrypt.

Eileen Lyon, general counsel and chief compliance officer at Kik, dismissed these arguments in an interview with Decrypt.  "The notion that Kik erred by purchasing insurance is silly. We were in talks with insurance brokers a full month before even the DAO report was issued,” she told Decrypt. 

“Given the uncertainty that still exists, it was only prudent to seek proper insurance coverage,” she said, especially since “the SEC has a tendency to overreach.” To Lyon, arguing that seeking insurance is damning evidence is “like saying one would only buy auto insurance if they believe themselves to be a bad driver,” she added.

Straining too hard

But Boiron argued there’s also another reason to believe that the ICO sale is also an “investment contract” under the Howey Test: Kik would have to work on the network to increase its value. 

SEC noted that Kik repeatedly vowed to integrate Kin into its messenger and promised to develop the ecosystem. This would increase the value of tokens, another reason to believe that investors expected profits. 

“Kik tries to argue that any of its efforts were only to build out the infrastructure as one of many participants in the ecosystem,” said Boiron. It argues that Kin’s price is based on supply and demand driven mainly by other people, rather than Kik itself—just like any other cryptocurrency, such as Bitcoin. 

“This really seems to be a way of pulling the wool over the eyes of a court that may not understand the cryptocurrency market,” he said—”an attempt to confuse the court into agreeing with Kik’s position. I don’t think this will go over well because of how clearly the SEC can show the difference,” he said.

The prolonged legal dispute with the regulator proved costly for Kik. Its 300 million-strong messaging app was almost shut down last October, and the Kik corporation laid off the bulk of its staff. With emptied coffers, can Kik hold on long enough to fight its cause?

Editor's note: This article was updated after publication to include quotes from Eileen Lyon, general counsel and chief compliance officer at Kik; Marc Boiron, partner at law firm FisherBroyles; a Kik spokesperson; and further evidence from both the SEC and Kik's motions for summary judgments.