Legal Guidance on the SEC’s Cryptocurrency and ICO/STO Regulations
SEC Registration & Compliance
In March 2018, the Securities and Exchange Commission (SEC) first announced that all platforms used for exchanging cryptocurrencies which are also securities are required to register with the agency (under longstanding rules requiring securities exchanges and alternative trading platforms to register).
“If a platform offers trading of digital assets that are securities and operates as an ‘exchange,’ as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration,” the SEC said in a statement.
The SEC also warned that despite appearances, many places where cryptocurrencies are presently being exchanged aren’t SEC-registered and are actually “potentially unlawful.”
“The SEC staff has concerns that many online trading platforms appear to investors as SEC-registered and regulated marketplaces when they are not,” the SEC said. ” Many platforms refer to themselves as ‘exchanges,’ which can give the misimpression to investors that they are regulated or meet the regulatory standards of a national securities exchange.”
Citing an intention to aid and protect investors, the SEC also included tips for investors on how to best choose the proper platforms for trading cryptocurrency.
The announcement adds to the regulatory agency’s increasing effort toward achieving better oversight over the platforms and exchanges where cryptocurrencies are traded.
Earlier in 2018, SEC Chairman Jay Clayton appeared before the United States Senate to express concerns over potential price manipulation on cryptocurrency exchanges. He also lent his support for categorizing many digital tokens as securities and regulating them accordingly.
Clayton not only promised further SEC scrutiny into cryptocurrencies but increased enforcement action as well. As a result, the SEC in the Spring of 2018 launched an internal probe of many Initial Coin Offering (“ICO”) projects and associated cryptocurrencies, issuing numerous subpoenas and information requests to companies issuing digital tokens.
In April 2019, the SEC release further guidance through FinHub, which although it’s not official guidance, provides examples of appropriate and inappropriate applications of securities laws for token sales.
With such heightened scrutiny from regulators only likely to increase, the need for strong compliance with the SEC is not optional for any company seeking to launch digital tokens in the lucrative American market. There are three important aspects to staying compliant with SEC regulations:
- SEC scrutiny and enforcement actions will have a negative impact on public relations, which is a crucial aspect of any emerging cryptocurrency.
- With the SEC now more actively providing guidance for cryptocurrency-related investment, the agency is establishing itself as a de facto clearinghouse for potential investors. Landing on the wrong side of the SEC, even if mistakes or missteps are innocent oversights (and even if the SEC loses or drops a particular enforcement action), will lead to diminished consumer and investor confidence, and ultimately to substantial lost investment opportunities.
- With the SEC issuing formal subpoenas to companies issuing digital tokens, the demand for compliance is greater than ever. Not only do investigations consume precious time and money, but they also expose companies (and their officers) to an extensive level of legal scrutiny that nobody would choose willingly.
At IBC, we will connect you with legal experts who will help you navigate the potentially treacherous waters of SEC compliance with a laser-sharp focus on protecting you and creating an environment for you to focus on growing your business instead of worrying about the pitfalls of legal liability. By taking a proactive approach, we will not only guide you in light of existing SEC and other regulatory compliance guidelines and best practices, but also utilize our global network to identify trends and emerging issues to keep you ahead of the competition.
ICO Fund Formation & Structuring
The cryptocurrency attorneys who work with IBC’s clients come from around the world, drawing on their exceptional skills in international business law to provide vital know-how when it comes to forming and structuring your Initial Coin Offering fund. Our team of legal experts helps to assist clients in the formation and proper structuring of funds in an array of countries, bringing a powerful collection of opportunities to the table to ensure you have every conceivable option possible. We assist with international banking and fund compliance as well making certain that operations remain within relevant regulatory frameworks.
A fundamental first step to forming and structuring an Initial Coin Offering fund is researching the laws to make sure ICOs are lawful in your jurisdiction. Because of the proliferation of ICOs being exposed as scams, suddenly shutting down while taking investor funds with them, ICOs are currently the most regulated aspect of cryptocurrencies.
Only China and South Korea have completely banned ICOs in their respective jurisdictions; just about everywhere else in the world, Initial Coin Offerings are legal, regulated or subject to future regulations. The degree of these regulations differ extensively among countries, something you should unquestionably take into account when considering the jurisdiction of your ICO.
Citizens of the United States must disclose any income earned and wealth held overseas to the Internal Revenue Service (IRS) for tax purposes. Additionally, the US Security and Exchange Commission (SEC) is prosecuting ICOs that are not compliant with their increasingly stringent guidelines. Because of these regulatory hurdles, a rising number of projects have completely banned US citizens from purchasing their tokens.
Not only must you adhere to all pertinent laws and regulations, but you need to be absolutely transparent in how you will handle other people’s money. Every facet of the project must be planned to the very last detail.
Legal Structures for Initial Coin Offerings
Launching an ICO can be considered somewhat precarious because of a rapidly evolving regulatory landscape. Because ICOs are comparatively new, there is precious little case law and other jurisprudence to govern your decision-making process. Your first task should be to minimize your risk, which means you need a powerful corporate structure to limit your liability.
Failing to use a legal entity to form and structure your Initial Coin Offering fund means you would operate as a general partnership. Under this framework, each partner is jointly and severally liable for the fund. In essence, you and all of your co-founders are each individually responsible for any liability arising from the business. Given the vast number of legal, regulatory, and market variable associated with forming an ICO fund, assuming this degree of personal liability could only be characterized as utterly insane.
By comparison, forming a legal entity will not only reduce your personal liability but also provide a corporate veil for additional protection. Like any other business, a proper ICO corporate structure is an absolute must. Although several processes exist by which one can legally present their initial coin offerings, the overwhelming majority falling under one of three categories: corporations, LLCs or foundations.
What entity is the best fit for you?
A threshold consideration is whether a foundation or a company is a stronger entity type for your specific project. Unlike a company, a foundation has no shareholders or owners. Foundations are hybrid in structure, having components of a corporation such as legal personality (to limit legal liability) and a trust created for a purpose or benefit (to limit financial liability).
Although popularly used for token issuances, a foundation may not be the ideal instrument to carry out an Initial Coin Offering, primarily because foundations were not designed to engage in commercial transactions.
Foundations issuing tokens take on a significant degree of risk because anybody who purchases a token is technically making a donation to the foundation. One of the distinguishing characteristics of a donation is that the donor does not receive something of equal value in return. Receiving tokens in exchange for donations would seem to violate this basic concept on its face, thus opening the foundation to extensive legal scrutiny. If this process sounds sketchy, that’s because it is indeed quite sketchy and would not be considered a best practice for forming and structuring your ICO fund.
Based on these considerations, it likely makes better sense to establish an entity suitable to perform commercial activities, including the sale of tokens. An attractive option is a Limited Liability Company (LLC), which is an entity with considerable legal flexibility designed to benefit the owners, known as members. Most LLCs are governed by an operating agreement signed by all the members, allowing you wide latitude in enacting rules in the best interest of you and your company. Because liability protection is normally the primary consideration when forming and structuring an ICO fund, it is obvious to see why the capacity to include additional protections via an LLC operating agreement is such a value proposition. You can even combine the issuing entity with a Trust for more protection.
Although a Foundation is not necessarily the appropriate corporate entity for the sale of tokens for reasons articulated above, it should not be entirely rejected. Once the tokens are sold, a Foundation can be an efficient, and in some respects highly powerful vehicle to manage the proceeds and tokens accrued by the ICO.
There is no law prohibiting a Foundation from maintaining its own assets in its own name, so long as the such activity stays consistent with the purposes set forth in its constituent documents. Additionally, the administration and operations must be carried out by the Members of the Board in accordance with the Foundation’s by-laws.
Why would you choose to create and maintain a Foundation as the legal entity for the purpose of asset management? As non-profit organizations, foundations can be established solely to carry out a purpose. And because the mission is not for the benefit of individual wealth, foundations can enjoy a decidedly advantageous tax status.
To avoid legal scrutiny, the Foundation can be established purely for the purpose of developing an ecosystem or software, not for the benefit of people. However, the Foundation can lawfully make grants to the operating companies to perform work on its behalf, thus establishing operations at an arm’s length agreements for both tax and legal reasons.
By insulating the structure issuing the tokens from the structure responsible for the ongoing operations and development of the project, you split the legal liability associated with the sale itself from the liability associated with the ongoing operations of the network.
Another key component of this approach is flexibility. By choosing different legal entities for each phase based on the most pressing legal needs at that stage, you may be able to dramatically reduce your legal burden. You may also be better positioned to establish operations in multiple countries with easier access to banking, financial services, and tax optimization.
By retaining top-notch legal counsel, like the law firms who regularly work with IBC’s clients, the sky is truly the limit for your ICO fund. These are the kinds of innovative yet elegant solutions that the team of legal professionals in IBC’s network takes immense pride in delivering for our clients.