Still Struggling With ICO Accounting

There is precious little information on ICO accounting out there.  I blogged about it recently here.  It is a big issue.  Tax consequences can be huge.  The cleanest path to an ICO is not to make the token that is being issued securitized.  That means it merely has the right to participate in whatever the company is building.  If that’s the case, I can see how there should be no corporate or other tax paid on the issuance since there isn’t any securitization value associated with it.

What’s really interesting to me is to compare that train of thought to what I experienced while on the board at CME.  If we take CME and compare it to token issuance, the tokens clearly are the memberships.  The memberships contained core rights and privileges but were not shown as equity on the balance sheet.  It doesn’t matter what balance sheet we look at for these purposes.  Here is an old one.

CME GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in millions, except par value data; shares in thousands)

(unaudited)

September 30, 2017
December 31, 2016
Assets
Current Assets:
Cash and cash equivalents
$
1,631.1
$
1,868.6
Marketable securities
88.0
83.3
Accounts receivable, net of allowance of $1.4 and $3.5
390.3
364.4
Other current assets (includes $50.0 and $30.0 in restricted cash)
340.8
171.7
Performance bonds and guaranty fund contributions
46,942.3
37,543.5
Total current assets
49,392.5
40,031.5
Property, net of accumulated depreciation and amortization of $649.9 and $597.2
388.9
425.2
Intangible assets—trading products
17,175.3
17,175.3
Intangible assets—other, net
2,370.0
2,441.8
Goodwill
7,569.0
7,569.0
Other assets (includes $2.2 and $61.7 in restricted cash)
1,427.3
1,726.6
Total Assets
$
78,323.0
$
69,369.4
Liabilities and Equity
Current Liabilities:
Accounts payable
$
36.1
$
26.2
Other current liabilities
244.6
1,376.7
Performance bonds and guaranty fund contributions
46,942.3
37,542.7
Total current liabilities
47,223.0
38,945.6
Long-term debt
2,232.6
2,231.2
Deferred income tax liabilities, net
7,437.0
7,291.0
Other liabilities
566.5
560.9
Total Liabilities
57,459.1
49,028.7
Shareholders’ Equity:
Preferred stock, $0.01 par value, 10,000 shares authorized at September 30, 2017 and December 31, 2016; none issued
Class A common stock, $0.01 par value, 1,000,000 shares authorized at September 30, 2017 and December 31, 2016; 339,115 and 338,240 shares issued and outstanding as of September 30, 2017 and December 31, 2016, respectively
3.4
3.4
Class B common stock, $0.01 par value, 3 shares authorized, issued and outstanding as of September 30, 2017 and December 31, 2016
Additional paid-in capital
17,874.6
17,826.9
Retained earnings
2,973.8
2,524.5
Accumulated other comprehensive income (loss)
12.1
(14.1
)
Total shareholders’ equity
20,863.9
20,340.7
Total Liabilities and Equity
$
78,323.0
$
69,369.4

CME shows the value of their memberships in the equity portion of the balance sheet. It is an anomaly.  When the exchange demutualized in 2001, the IRS and SEC made specific rulings around the change from non-profit to for-profit. It took over a year for the IRS to rule that it was a tax-free transition.  In that ruling, the agency said that in order to keep it tax-free, CME would have to securitize their memberships by stapling one share of CME Class A common to each B share.  The B shares were formally referred to as “memberships”.  By the way, to show how difficult a process this is, Sidley and Austin totally screwed it up the first time through.

Hence, today if you own a B share at CME you get a dividend per share. In ICO land that makes the path to an ICO a lot more difficult from a regulatory perspective.  Legal and regulatory costs are much higher if you want to securitize your token.

Notice, CME doesn’t list the value of the B-Shares on their balance sheet.  They don’t own them, the B-shareholder does.  CME generates revenue from the memberships. Those memberships still have rights to access the “CME blockchain”, which is the trading platform and clearinghouse.  The fees generated from those memberships is booked as revenue and flows through the income statement and onto the balance sheet.

I thought about when the B-4 shares  (GEM) were issued at CME.  It was around 1993 or 1994.  It was incredibly controversial at the time and was the spark that ignited the movement to pave the way for the exchange to change.  At the time, CME was a non-profit so the issuance of the new memberships was treated under GAAP non-profit accounting, not for-profit accounting.  My friend Yra thinks the proceeds might have gone into the clearinghouse to recognize the added risk the exchange was assuming by adding another member class.

It would behoove the Financial Accounting Standards Board (FASB) to get their heads together and issue generally accepted accounting procedures (GAAP) around how to account for ICOs.  That would give guidance to the IRS and SEC.  The AICPA needs to get in gear.  There is no doubt they will issue some regulations around this by the end of this year.  Having FASB weigh-in prior to regs being issued would allow the private market to help the process along.  It’s a big issue.  Over $3B has been raised via the ICO market.  It’s not going to stop and it is important that investors have a standardized way to read financial statements.