A recent Philippine Securities and Exchange Commission (“SEC”) Advisory reiterated its message to those conducting Initial Coin Offerings (“ICO”) of security tokens within the country: register your security tokens or be prepared to face penalties.

Just this month, the SEC declared that the Ploutos Coin is a kind of security which must be registered first in accordance with the Philippine Securities Regulation Code (“SRC”) before it can be offered to the public. The Ploutos Coin was created and promoted by the Freedom Traders Club as an investment vehicle whose value will allegedly skyrocket through its projected supply and demand.

However, being an unregistered security, the SEC advised the public to exercise caution before investing in the said ‘coin’. It also warned that those who facilitate, aide, or abet in the sale or promotion of the Ploutos coin could face criminal penalties under the SRC and other criminal laws.

The SEC’s characterization of the Ploutos Coin as a kind of security was made on the basis of the Howey Test – a test derived from U.S. jurisprudence – to determine whether a transaction qualifies as a security classified as an investment contract. The Howey Test has four requisites, namely: the investment of money; a common enterprise; the expectation of profit; and an increase in value primarily derived from the efforts of others. Thus, a token or coin that satisfies all the requisites of the Howey Test must secure a prior registration and license to engage in the sale of securities from the SEC. In such case, a registration statement and prospectus may be required prior to the ICO, unless exemptions under the SRC apply.

This, however, only applies to ICOs offering security tokens which are clearly within the SEC’s regulatory purview.

The Rise of ICOs in the Philippines

A novel method of raising capital, the ICO gained momentum following the meteoric rise of the blockchain technology and of cryptocurrencies. Similar to an Initial Public Offering or an “IPO”, an ICO is also a method of raising capital for startup companies. However, unlike subscribing to shares of stock in a company, the SEC, in its Advisory issued in January 2018, defined an ICO as the first sale and issuance of a new virtual currency to the public usually for the purpose of raising capital for startup companies or of funding independent projects.

Because of its accessibility and wide applicability, several Philippine-based startups have dipped their toes into ICOs as innovative capital-raising vehicles. However, due to the lack of clear and specific laws and regulatory issuances about ICOs, it comes as no surprise that most of these startups have opted to conduct their ICOs outside the Philippines and in more crypto-friendly jurisdictions.

How to Conduct an ICO

Conducting an ICO is a complex and new process. A company that intends to conduct an ICO very often starts with a whitepaper, which typically contains all the necessary and credible information about the coin or token’s technical processes. Good white papers also reveal the management team, legal structure, and corporate organization of the ICO proponent.

A company launching an ICO is expected to transparently set forth all details about their financial plan and implementation timeline. They must also aim to comply with the highest level of technical protocols and relevant financial market regulations of jurisdictions where they intend to introduce their coins or tokens. Furthermore, a clear and full assessment of the risks related to the technology underlying their coin or token is usually disclosed. More often than not, such company must also engage a (preferably independent) technology auditor who can certify the technology’s high level of protection and transparency before ICO investors.

Understanding Cryptocurrencies

Having a good grasp of cryptocurrencies will be key to understanding ICOs. A cryptocurrency, or alternatively, virtual currency, is essentially a form of decentralized digital currency recorded in a distributed public ledger more popularly known as the ‘blockchain’. In the same January 2018 Advisory, the SEC defined a virtual currency as a digital representation of value issued and controlled by its developers and used and accepted by and among members of a specific community. These cryptocurrencies, tokens, or digital coins, can be acquired or exchanged through a Virtual Currency Exchange (“Exchange”) platform.

In relation to ICOs, the SEC likewise stated its view that some of the virtual currencies in the market, based on the facts and circumstances surrounding their issuance, follow the nature of a security as defined under the SRC, similar to the Ploutos Coin. As such, there is a possibility that a company intending to conduct an ICO offering security tokens will be required by the SEC to first register its virtual currencies in compliance with securities law. The SEC has not, however, expressed its view on how to treat utility tokens.

Unlike security tokens, utility tokens are arguably not the same as security tokens. In contrast to security tokens, they do not primarily derive their value or gain profit from mere holding of the tokens as the potential earnings are not tied to the growth or market value of the issuing company. Typically, the main use of utility tokens, as the name suggests, is to allow access and use of certain products and services on a platform to token holders. As such, utility tokens, arguably, do not fall under the same boat as security tokens which require SEC registration and licensing. However, a SEC determination to this effect has yet to be made.

The Philippine Approach to ICOs and Cryptocurrencies

While the SEC and Bangko Sentral ng Pilipinas (“Central Bank”) or the Central Bank of the Philippines have yet to produce substantive regulations specifically and directly applicable to ICOs and cryptocurrencies, following direct consultations with key officials, both government agencies have shown their openness and willingness to act as enablers for blockchain initiatives in general and for ICO proponents in particular.

The SEC has expressed a willingness to take on a “sandbox approach” with respect to blockchain startups and their ICOs. This validates the SEC’s current policy posture to process and not outright reject or deny such applications, provided that threshold issues concerning legitimacy (or absence of fraudulent activity) are hurdled.

Central Bank regulators have similarly expressed the view that they are approaching virtual currencies and Exchanges on a “test and learn” basis, which means that regulators ought to welcome innovative activity first before formulating and applying regulations onto that activity. In its Memorandum Circular 944 (Series of 2017) which sets forth its current regulatory posture on virtual currencies, the Central Bank recognized Exchanges as a revolutionary method of delivering financial services and facilitating payment systems throughout the country. For this reason, the Central Bank classified Exchanges as services similar to remittance and transfer companies who fall within its regulatory purview. As a caveat, the Central Bank stressed that it only aims to regulate virtual currencies when used for delivery of financial services, particularly, for payments and remittances, that is, when there is an actual exchange from virtual currency to fiat or legal tender and vice versa.

However, the Central Bank has emphasized in its Advisory on the Use of Virtual Currencies issued on December 29, 2017 that it does not aim to endorse particular virtual currencies, such as Bitcoin, as they are not backed by any central bank guarantee or by any underlying asset or commodity. It also advised the public to deal only with Central Bank-registered Exchanges and to maintain sufficient amounts of virtual currencies to address transaction requirements.

On the part of the private sector, the Philippine Stock Exchange, Inc. (“PSE”) has yet to issue an official statement on cryptocurrencies and/or ICOs in general or on whether it will classify and admit cryptocurrencies in the exchange as an entirely new asset class.

The Philippines as a Tech Incubator

The Cagayan Economic Zone Authority (“CEZA”) is an economic zone established by law with a mandate to stimulate economic growth by developing a self-sustaining industrial, commercial, financial, and tourism-recreational center. As a Freeport, it operates as a separate customs territory. The CEZA promotes itself by seizing new business opportunities through the provision of attractive incentives and advantages for interested investors who register in its economic zone. Showing the Philippine Government’s openness to this technology, the CEZA has entered into twenty-two agreements with offshore FinTech and blockchain companies which are interested in operating in the special economic zone and which intend to engage in crypto-mining, blockchain production, and the Exchanges.

Mark S. Gorriceta is the Managing Partner of Gorriceta Africa Cauton & Saavedra (GorricetaLaw).  GorricetaLaw is a law firm in the Philippines, represents entities involved in several blockchain initiatives and continues to assist companies involved in the emergence of virtual currencies throughout Asia. Additionally, GorricetaLaw is legal adviser to some of the top tech companies in the Philippines.

Many thanks to Liane Candelario, Kristine Torres, and Edsel Tupaz for their thoughts and comments.

Note: In order to avoid confusion, this article has been updated to reflect the difference between the security tokens that are the subject of the current regulation and utility tokens.

Suggested citation: Mark S. Gorriceta, “Philippines Emerging Virtual Coin Investment Regulatory Framework,” JURIST – Academic Commentary, Jul. 24, 2018, https://www.jurist.org/commentary/2018/07/mark-gorriceta-philippine-ico.

This article was prepared for publication by Kelly Cullen, the JURIST Managing Editor. Please direct any questions or comments to him at commentary@jurist.org