The Securities and Exchange Commission (SEC) shook the cryptocurrency and ICO world to its core exactly a year ago, in July 2017. They issued a report stating that decentralized autonomous organization (DAO) tokens were securities, and therefore fell under U.S. federal securities laws.
Later that fall, an ICO was actually shut down by the SEC after they determined it was a security (this despite the company having obtained legal counsel stating they were offering a utility rather than a security token). Fear was struck into hearts and legal entities scrambled to make sense of the implications.
Eventually, it was determined that several legal paths were available to future ICOs.
Private Pre-Sale ICO
Private Pre-Sale ICOs, which normally take place prior to or possibly in lieu of public offerings, can be structured as a Private Placement ICO. This happens legally under SEC Rule 506(d). Due to the September 2017 shutdown of a utility token sale, the Rule 506(d) option is considered the safest legal route to conduct ICO Private Sales in the U.S.
The IPO registration route is not only costly and time-consuming, it is also rarely used. The nature of ICO launches and the distinct shift to Private ICO funding has rendered this option nearly obsolete in the cryptocurrency space.
Part of the SEC’s Regulation D, Rule 506(c) allows for an exemption from registration for Private Placement ICOs. Under this exemption, accredited investors with over $1 million in capital or $200,000 in annual income ($300,000 if investing jointly with a spouse) can participate in Private Funding ICOs. In addition to available assets, investors must also be able to demonstrate a working knowledge of finance and business. In other words, they need to know what they are doing and be able to easily prove it.
One challenge under this rule is that advertising is not allowed. Therefore, substantial relationships must be developed far in advance with accredited investors through ICO private placement memoranda in order to remain in compliance with this Rule.
There may, however, be a way to easily comply with the no advertising rule found in Rule 506(c), and it is located in Regulation A+. Regulation A+ not only allows for a “mini-registration” in total compliance with the Securities Act, it also permits general advertising and solicitation. For ICO private placements, the registration is less important than the advertising allowance, as it opens the door to seeking private ICO funding through more traditional advertising avenues than the completely restrictive Rule 506(c) does.
Another interesting component of the Securities Act for Private Placement ICOs, Regulation S exempts U.S. companies who trade exclusively with non-U.S. companies from operating under the regulatory requirements of the U.S. SEC. Unfortunately, most states do not contain the same exemption in their securities law, which could cause potential future issues even though most states also don’t regulate securities sales to out of state purchasers.
This brief introduction contains only a small piece of the legal and regulatory ramifications for Private Sale ICOs. It is recommended that all projects using ICO Private Funding seek expert legal counsel prior to and during their Private Sale launch.