On September 3rd, hotel heiress Paris Hilton tweeted to her 16 million-plus followers that she was “looking forward to participating in the new @LydianCoinLtd Token,” noting in a hashtag: #ThisIsNotAnAd. It was a high-profile mention for the Signapore-based LydianCoin Pte. Ltd., which aims to raise $100 million through its still-unscheduled token sale. The endorsement was a boon for the little-known firm — at least until Hilton deleted her tweet a few weeks later. (After publication, a Hilton spokesperson said she is no longer involved with Lydian.)
While a $100 million initial coin offering is almost run-of-the-mill these days, the LydianCoin ICO is noteworthy for both what it had—high-power celeb endorsement—and what it lacks. Tokens that might be worth investing in typically represent some sort of technological advance, but LydianCoin itself states that its tokens aren’t much more than a way to pre-pay the company for the services of its parent company, ad tech firm Gravity4. And, like many tokens entering the market, LydianCoin faces uncertainty around which types of tokens the Securities and Exchange Commission might rule to be securities, and thus subject to a raft of SEC regulations.
Further complicating matters are the ongoing legal issues facing the head of Gravity4 and LydianCoin, Gurbasksh Chahal — an Indian-American Horatio Alger who sold his first company at age 18 for $40 million (or possibly $25 million). In 2014, he pleaded guilty to abusing his then-girlfriend. Now, he not only faces possible jail time for violating probation — after allegedly kicking another woman — but he is also being sued by at least four former employees for harassment and discrimination. Three of those lawsuits name Gravity4 as a co-defendant, citing harassment in the workplace. Chahal has called the allegations against him “baseless” and “frivolous.”
Chahal’s entrance into crypto assets — with or without Hilton’s tweeted endorsement — is part of a new digital gold rush, in which separating real companies from scams and get-rich-quick schemes can be increasingly difficult. Right now crypto is a lightly regulated space in which the foolhardy are going into debt to buy new tokens — a few of which have seen their values rise 1,000- to 5,000-fold since their ICOs, but which carry significant risk.
According to CoinDesk, all-time funding from ICOs, also called token sales, exceeded $1.8 billion by the end of August, up from $295 million at the start of this year — and the pace is only quickening. And TokenData, which has catalogued 625 ICOs in 2017 in total, says four closed in January, 15 in April, 65 in August, and by month’s end, 132 will have completed in September. In the frenzy, the savvy and the imprudent are transacting with both visionaries and the unscrupulous.
Fundraising on Borrowed Time
The video LydianCoin uses to advertise the company shows the highlights of Chahal’s life, from smiling with Barack Obama to sitting on Oprah’s couch to audience applause.
What it omits are his mug shots after the tech mogul was arrested twice for alleged violence against women. In 2013, Chahal was caught on video hitting his girlfriend 117 times. After he was charged with 47 felonies, a judge ruled that the video was not admissible as evidence because of how police collected it. In April 2014, Chahal pleaded guilty to two misdemeanor charges of battery and domestic abuse. He was sentenced to three years of probation, along with 25 hours of community service and ordered to attend a domestic violence training program. By October of that year, he was arrested again for violating his probation after another woman alleged that he had kicked her multiple times. A representative for Chahal called the police report on the incident “false” and “baseless.” In August 2016 Chahal was sentenced to a year in jail for violating probation, a ruling he immediately appealed.
Now a year later, Chahal is running the LydianCoin launch on borrowed time as he awaits a court decision on the appeal for his probation case. If Chahal fails to win the appeal, he will be taken into custody or have a time arranged for his surrender, a San Francisco District Attorney’s Office spokesperson told Forbes. (Chahal and Gravity4 did not respond to requests for comment.)
More Legal Hot Water?
According to LydianCoin, owners of the tokens, named for the first civilization to use coins, get exclusive access — but only for a limited time — to products under development by Gravity4, including MonaChain, described as “a blockchain-driven anti-ad fraud system,” and MonaBrowse, which will provide an ad-free web browsing experience. But the main purpose of Lydian tokens is to pay for Gravity4’s marketing services and products — which could be done in, well, dollars. As the LydianCoin white paper puts it, “Why Use Lydian To Purchase Services Available for Purchase with Fiat Currency?” (The response is a bunch of words that do not contain the answer.)
Chahal’s personal legal challenges aside, his company is now diving into an area where regulations aren’t entirely clear. The rules around the issuance of digital tokens and when they classify as securities are currently being formulated in the U.S. Those classified as securities would be required to register as such with the SEC and include all proper disclosures for investors.
Whether or not Lydian tokens are securities would be determined by a judge – and that would happen only if LydianCoin is ever sued by an investor or the SEC. In July, the SEC issued a report declaring a now-defunct token called DAO tokens securities. Prior to that, in December 2015, it sued Josh Garza, GAW Miners and Zen Miner for a fraud that included an announcement to launch of Paycoin as a way of prolonging their fraud. (The SEC declined to comment about LydianCoin.)
What is known as the Howey test is often used to determine whether an offering is a security; it was cited in the SEC’s main guidance thus far on crypto assets — the July report on DAO tokens. Peter Van Valkenburgh, a lawyer and the research director at cryptocurrency advocacy organization Coin Center who is well-versed in how securities law applies to these new types of assets, said the LydianCoin could meet all four of the Howey test’s prongs, which would classify it as a security. The four prongs are that the offering be (1) an investment of money in (2) a common enterprise (3) where there is an expectation of profits (4) that comes only from the efforts of the promoter or third party.
LydianCoin seems to meet these criteria, said Van Valkenburgh, because, “the economic realities of something with promotional materials like LydianCoin is people believe they’re going to get rich based on the efforts of the person selling them the tokens. The purpose of the [LydianCoin] is to raise money by offering this liquid asset. And it is suggested heavily by the marketing materials that the value of the asset will skyrocket relative to the efforts of the third party. And you should buy them now in order to get in on the ground floor.”
Lawyer Stephen Palley of Anderson Kill said of the LydianCoin white paper, “They use the word utility token more than once, and the talismanic usage of a word like utility token doesn’t necessarily mean it’s legal.” A utility token is a coin that has a function beyond just speculative value, similar to the way someone purchasing a Manhattan condo is likely to profit from its value going up, but they’re buying it presumably because of its utility as a habitat. “I’m not saying this thing is legal or not illegal,” said Palley. “I’m just saying that using words like utility token doesn’t guarantee anything.”
However, maybe because of the risk that it could be deemed security, even compared to other coins, the Lydian token is carefully structured to obtain what is called safe harbor under rule 506 of Regulation D (and the white paper states they are making this offer “in a manner substantially similar” to that exemption). Under Reg D, the issuer makes an offering that would typically be considered an unregistered security but does so in accordance with certain strictures, such as requiring that U.S. buyers be accredited investors with a net worth of over $1 million or an annual income of $200,000. The risk Chahal runs is, if the company fails to comply with all conditions of the safe harbor provision, he could be found to be issuing an unregistered security. The penalties for that could be as little as a few thousand dollars and as severe as 20 years in jail. And someone found issuing an unregistered security could also be required to hand over all profits from the offering.
A Bad Deal For Buyers?
Assuming Lydian meets the conditions for safe harbor, what Lydian token purchasers may not realize is that buyers purchasing securities under safe harbor cannot sell them for a year — a fact not mentioned in the Lydian Coin white paper, though it does ask every purchaser to “represent in writing that it is acquiring the Lydian tokens … not with a view to resell or distribute such securities.” Since many token buyers participate in ICOs in order to sell on secondary markets and turn a profit, this restriction could make Lydian unappealing to them.
But even for those buying and holding (or “hodling” in Bitcoin parlance), there isn’t an obvious value to the token. “The promo materials are absolutely vague as to the actual underlying purpose or technology or anything to do with the fundamentals of the project,” said Van Valkenburgh. “From looking at the promotional materials, the fairly nonsensical white paper and the personal history of some of the people involved, I would be extremely skeptical about whether there’s any technology here or just an attempt to raise a lot of money off the hype of the ICO bubble.”
As Marco Santori, a partner at law firm Cooley who specializes in law concerning blockchain technology but had not read the LydianCoin white paper, said, “Why would I give you my dollar today for the promise of a hamburger tomorrow, if I can just pay for the hamburger tomorrow?” he said. He also noted that the secondary market for such a token would be rather flat. “If I just sell a gift card at a dollar for a dollar, like store credit, I don’t know what the investment use case is there,” he said.
Palley agrees. Noting that purchasers need to provide identification and verification of their accredited investor status to buy tokens, he concludes, “It’s not the most ridiculous thing I’ve seen. What I come back to is I’m just not sure why you need a token to do this.“
If Gravity4 succeeds in raising money this way, it will create $100 million of liability on its books. And if the company’s founder loses his appeal and ends up serving jail time, and Gravity4 has to pay damages in any of the pending employment-related lawsuits, the company’s ability to deliver the services it has already promised could be in question.
A Risky Endorsement
While Chahal may have nothing to lose by further tarnishing his already besmirched reputation, being associated with LydianCoin might not be a good look for anyone who endorses it.
That may be why Hilton deleted her tweet and now says she is no longer involved with the new venture by Chahal, a violent criminal whose past was more thoroughly revealed in a Daily Beast article, “Silicon Valley CEO Called Employees the N-Word and Hit Three Women, New Lawsuit Claims,” last week. Plus, as Fortune noted in a story on celebrity-backed ICOs, Hilton and other big-name backers of cryptocurrencies do so at their own legal risk.
And considering the possibility that Chahal could serve jail time, the four lawsuits hanging over him and the narrow tightrope the offering may be walking trying to comply with securities law, LydianCoin investors also bear risk, but of a different kind.