Understanding the Various Regulatory Options Available for U.S. ICO/STOs
For the previous 80 years, the United States government regulated private businesses in their capacity to raise capital. Under these previous limitations, companies could only raise capital from a group formally known as accredited investors. The textbook definition of an accredited investor means someone who is part of the wealthiest 2% of all Americans.
These rules changed substantially on April 5, 2012, when President Barack Obama signed The JOBS Act. This landmark legislation allowed entrepreneurs to enlist the public to essentially use the concept of crowdfunding to raise capital. Four years later, on May 16, 2016, Title III of the JOBS Act went into effect as part of the original legislation. Also known as Regulation CF, this provision allowed private companies in their early stages of development to raise money from any American, regardless of whether they meet the criteria of an accredited investor. These changes to the law allow startups to use equity crowdfunding to turn customers into investors.
According to Title III of the JOBS Act, Regulation CF, is a specific type of offering allowing private companies to raise up to $1 million from all Americans. Much like a Kickstarter campaign, Regulation CF will enable companies to raise funds online from their early adopters and other public investors. But instead of rewarding these crowdfunding investors with a token reward such as a t-shirt, the token, in this case, is taken much more literally as investors receive securities in exchange for backing a startup. These securities usually, but not always, come in the form of equity in the company.
Regulation CF allows you to raise up to $1,070,000 throughout any 12-month period by selling your tokens, or securities convertible into tokens, to all investors, both accredited and non-accredited alike. To qualify, you must conduct your offering on an equity crowdfunding platform registered with the SEC. Additionally, the company must draft and file a Form C with the SEC before proceeding with its capital raise. It should also be noted that any securities that you issue as a result of a Regulation CF offering will be classified as “restricted securities.” This means that, with limited exceptions, the purchaser must retain the equity shares for a minimum of 12 consecutive months.
IBC works with companies throughout this process to make it painless and efficient by providing you access to our select group of exclusive attorney partners. It is essential to have qualified legal counsel on your side during the process to guide you through any potential landmines. For example, there are limitations as to how much any non-accredited investor is legally permitted to invest. And because your company is the issuer of the tokens being offered, you must be organized in the United States; however, the U.S. need not be your principal place of business.
Although the disclosure requirements mandated by the Securities and Exchange Commission for a Regulation CF offering are not overly burdensome, it is essential to make sure the existing provisions are strictly followed to avoid SEC scrutiny. Because crowdfunded offerings under Regulation CF are not only a relatively inexpensive way to raise capital but is also exempt from state laws requiring securities registration, their benefits should not be ignored by any company wishing to maximize the impact of their ICO.
Regulation D, Rule 506
The tokens acquired as part of an ICO typically present the buyer with some exclusive privileges on the issuer’s platform. The question of whether these tokens are considered securities has been debated since ICOs first came on the scene, and unfortunately, we still lack a reliable answer.
In recent months, the Securities and Exchange Commission has issued subpoenas to companies conducting ICOs based on the theory that the companies may have violated United States securities laws. However, with no hard and fast regulatory guidelines by which to navigate, companies wishing to raise funds via an ICO are left drifting when it comes to steering clear of the SEC. The resulting chaotic environment only serves to further cloud already murky waters for startups and developers. One thing certain for any company considering an ICO- the need for experienced legal counsel is a necessity, not an option.
The threshold question for any company prior to contemplating an ICO is whether they will recognize their offering as a security or utility token. If you are a cryptocurrency expert, you are likely familiar with the Howey Test, which is applied to determine whether or not a token is a security. Although the Howey Test can be a valuable tool, properly administering the test and understanding the results are extremely important components to a successful Howey analysis. Because of the serious consequences of the test, companies should consult experienced legal professionals prior to relying on the Howey test. At IBC, we have access to exclusive attorneys with the experience and know-how to make certain your analysis is not only accurate but will withstand SEC scrutiny. We know the fine line between carefully crafting your words for maximum impact and making statements that could be deemed misleading by regulators. Instead of taking a guess and hoping for the best, let us put our ICO experience to work for you.
If it should be ascertained that your proposed token is, in fact, a security, stay calm. You may still be able to conduct your ICO by qualifying for one of the exemptions the SEC has carved out for entities issuing securities. One common exemption can be found under Regulation D (Reg D) of the Securities Act.
What is Regulation D?
Simply put, Regulation D provides exemptions for private placement offerings. As a general rule, these offerings are conducted by smaller companies to generate capital funding via either debt or equity sales. The principal advantage for many issuers using the Regulation D exemptions is that they need not register the underlying securities with the Securities and Exchange Commission.
The SEC still requires issuing companies to furnish prospective investors with specific documents pursuant to the offering such as a Private Placement Memorandum. Additionally, all offerings taking advantage of Regulation D exemptions must still comply with relevant federal securities laws governing anti fraud and civil liability. However, the real benefits of a Regulation D offering come in the form of reduced costs, both monetary and in terms of time. These cost savings are substantial, with the resulting expense being far less than a traditional initial public offering. Issuers must likewise be mindful of any additional requirements under state law as part of a Regulation D offering, which is yet another reason to have IBC as part of your team.
Under Rule 506 (c) of Regulation D, a company can raise an unlimited amount of money by broadly soliciting and advertising their Regulation D, Rule 506(c) offering to the general public. The caveat here is that all funds raised under Rule 506 (c) must come from accredited investors, meaning the top 2% of the wealthiest Americans. It must be noted that the potential for raising large sums of capital is real; Filecoin raised more than $200 million in capital via an ICO under Regulation D, Rule 506 (c) in 2017. Although an ICO under Regulation D, Rule 506(c) tends to cost more than a Regulation CF offering, the overall cost is nevertheless cheaper than a Regulation A offering. As any securities sold pursuant to Regulation D are “restricted” securities (with a few narrow exceptions), all investors must maintain their equity for a minimum of 12 consecutive months.
IBC’s network of experienced attorneys can help you structure your Regulation D, Rule 506 (c) offering by working with you to draft offering documents, investment agreements, and advertising materials. We can also ensure your compliance with all federal and state filing requirements following your ICO. Although there are no specific formal disclosure requirements for Regulation D offerings, in some ways, the practical matters associated with a Regulation D offering are more onerous than a Regulation CF offering.
Because the disclosures required as part of a typical private placement memorandum include the steps necessary to verify that all of your investors are indeed accredited investors, there are additional inherent complexities to consider. But the lack of caps on the amount of money you can raise, coupled with the ability to widely advertise your ICO create an undeniable appeal for potential issuers.
Choosing the appropriate SEC Regulations to govern your ICO is a crucial decision that should not be taken lightly. The attorneys in IBC’s network know how to help your company analyze the pros and cons associated with your options and make the right call based on your specific needs and concerns. Contact IBC today to take your ICO to heights you never imagined.
Regulation A+ is like Regulation D in that both were passed into law as part of the JOBS Act signed by President Obama in 2012. Amendments to the JOBS Act in 2015 changed the classification from Regulation A to Regulation A+.
Regulation A+ is an exemption from the Securities and Exchange Commission registration requirements of various state and federal securities laws. Under this regulation, you can sell up to $50 million in tokens or token-related investments during any consecutive 12-month span. Regulation A+ offerings require the filing of an offering statement on Form 1-A with the SEC. After a period earmarked for review, revision, and comment by SEC regulators, this offering statement is then “qualified” by the SEC.
Regulation A+ allows your company to offer and sell their securities tokens to the general public. Unlike Regulation D offerings, an ICO under Regulation A+ can be sold to everyone, not just accredited investors. Under Regulation A+, any tokens or other securities sold are fully and freely tradable by the purchasing owner. The only resale restrictions are the ones your company may elect to impose as part of the framework of your token offering.
The disclosure requirements associated with a Regulation A+ offering are undeniably more stringent than for a Regulation D or Regulation CF offering, and the related financial costs are normally higher as well. But as an offset to these increased costs, the SEC allows Regulation A+ filers to submit their Form 1-A for confidential review. This measure of confidentiality allows companies to “test the waters” and build a following prior to publicly filing their offering statement for final SEC qualification. There is an additional caveat; in order to make use of Regulation A+, you must not only be a company organized in the United States or Canada, but you must also maintain your base of operations in that country as well. Despite the demands these conditions may place on foreign-based companies, the team of attorneys in IBC’s network have the comprehensive understanding of the Regulation A+ environment needed to help you plan, structure, file and qualify your Regulation A+ ICO while limiting your costs and maximizing your chances for a successful offering.
Tier 1 and Tier 2 Offerings Under Regulation A+
Regulation A+ offerings may be available through two options, which are generally available to U.S. or Canadian issuers. These offerings are only available to companies who are not presently subject to reporting requirements under U.S. federal securities laws and are not subject to a “bad actor” disqualification. All Regulation A+ offerings may be made directly to the general public and, unlike Regulation D, the coins or tokens issued as a result of the ICO are not considered to be restricted securities.
The first option, identified as a Tier 1 offering, enables a company to raise up to $20 million in any 12-month period. Any company conducting an ICO under this exemption must provide investors with an offering document (more specifically referred to as an offering circular). This document must be filed with both the SEC and any pertinent state regulators, and shall be reviewed by all applicable regulatory agencies before being qualified to progress to an ICO. The offering document must contain all appropriate information about the ICO as well as a description of the selling shareholders, the company’s business plan, management structure, performance metrics, strategic plans, and financial statements. The offering circular must also give a description of the proposed use of the revenues from the ICO and any identifiable risks. However, after this document has been properly filed with the SEC and any applicable state regulators, there are no further ongoing reporting obligations for the company.
The second option is called a Tier 2 offering. This type of Regulation A+ offering allows a company to raise up to $50 million in capital during any consecutive 12-month span. A offering circular document must still be filed with and ultimately qualified by the SEC, just like a Tier 1 offering, but there is one noteworthy difference. Tier 1 offerings are not required to be filed with any state regulatory agencies; the only filing jurisdiction is with the federal government.
But there is of course a catch. While Tier 1 offerings do not require ongoing reporting after the ICO is complete, Tier 2 offerings must report to the SEC. These reporting requirements also mandate the disclosure of financial reports. Additionally, individual investments in Tier 2 offerings are limited based upon the investors’ net worth. However, investors are permitted to self-certify their net worth, just so long as the company has no actual knowledge that an investor has exceeded their stated investment limit. Finally, while tokens or coins issued under either tier of Regulation A+ are not restricted securities per U.S. law, any secondary trades may be subject to qualification by state regulators under what are known as Blue Sky Laws.
Regulation A+ may be an attractive route for smaller companies issuing an ICO if the principal goals include raising capital through the offering of tokens or coins while avoiding some of the more burdensome disclosure requirements inherent in other types of ICOs. Companies can raise large amounts of capital under Regulation A+ and, unlike under Regulation D, are not bound by limitations restricting certain types of investors. Issuers need to be cognizant that there are some reporting obligations to federal (and potentially state) regulators for a company issuing an ICO under this exemption, with the possibility of ongoing reporting and disclosure requirements under a Tier 2 offering. However, issuers can take solace in the fact that these reporting requirements are not nearly as burdensome as they would be under a traditional initial public offering.
Choosing the precise route for your ICO can be challenging, which is why you need a devoted team of experienced attorneys working to guide your company every step of the way. Connect with some of the most prolific ICO attorneys in the industry by working with IBC to make certain your ICO is nothing less than a smashing success.
Under Regulation S, any offer and sale of securities tokens must be conducted outside the United States and solely to those people designated as “non-U.S. persons.” Any tokens or investment contracts such as Simple Agreements for Future Tokens (SAFTs) sold as part of a Regulation S offering are restricted securities, which means mandatory holding periods shall apply. Because of these restrictions against sales in the United States or to U.S. persons, meticulous attention must be placed on compliance structures. For instance, if you want to take advantage of Regulation S exemptions, you must create a geofence to block I.P. addresses in the U.S from your Regulation S offering website home page.
What is Regulation S?
Under Regulation S certain offerings can be excluded from the Section 5 registration requirements of the Securities Act of 1933, (the “Securities Act”), applying to offerings made outside the United States by both U.S. and foreign issuers.
Regulation S is comprised of five key rules:
- Rule 901 details the general policy that the US Registration Requirements only apply to “offers and sales” occurring within the United States and its territories;
- Rule 902 provides definitions to the language of Regulation S;
- Rule 903 includes a Primary Offer Safe Harbor provision for any transactions involving the issuances of securities that satisfy the specified guidelines;
- Rule 904 provides a Secondary Market Safe Harbor for all offshore resales in compliance with specified guidelines; and
- Rule 905 defines any equity securities sold by issuers in the United States in compliance with Primary Offer Safe Harbor (Rule 903) are deemed “restricted securities” as defined by the Securities Act and therefore subject to holding periods (and other related requirements) before they can be resold without restriction in the United States.
Regulation S is a process by which companies located both in outside the United States can raise capital in the US while staying compliant with SEC regulations. Under Regulation S, a company need not be located in the United States to raise capital.
A Regulation S offering can include both equity and debt securities. It also allows companies making their offerings under Regulation S to use an additional method to raise capital from US investors – usually under Rule 506 (C) of Regulation D.
Regulation S investors located outside the United States are not restricted by their degree of wealth. Regulation S often works in concert with Regulation D in that Regulation S allows investors outside the United States to invest in a company regardless of whether it is based in the United States or overseas. This is on par with the Regulation D terms, with no limitations in terms of only accredited investors.
Regulation S also requires that the offer and sale must be made available to investors located outside the United States. Additionally, all investors based in the United States are forbidden from being shown the terms for foreign investors.
There are no SEC registration requirements for Regulation S offerings, but there are rules and processes necessary for compliance. At IBC, our network of attorneys will work with you to write a Private Placement Memorandum (PPM) and Subscription Agreement for your offering to describe the investment from both legal and financial perspective. These documents will empower you to raise the capital you need with the assurance that you have an expert legal team guiding you every step of the way.
One possibility worth considering for your ICO is a combination approach. This could consist of doing a Regulation CF crowdfunding offering while concurrently conducting a private placement offering under Regulation D, Rule 506 (c).
A more intricate offering could combine a Regulation D, Rule 506 offering with an offering under Regulation S. This offering structure will enable you to expand your offering to both accredited and non-accredited investors alike. This flexibility allows you to broaden your pool investors and token holders to the full public, and the addition of a Regulation S component enables you to take advantage of valuable offshore investors.
At IBC, we will make sure you have access to a network of independent ICO lawyers who can counsel you on the potential positive and negative aspects of a combined offering. With expert legal counsel advising you on the best way to structure your ICO while providing key insights on regulatory compliance, your offering will be on the path to success.
SAFT (Simple Agreement for Future Tokens) or Securities Token Purchase Agreement
A Simple Agreement for Future Tokens (SAFT) is an investment contract that converts at a future date into a token. Similar to a SAFE (Simple Agreement for Future Equity), a SAFT can be utilized during the pre-sale phase of your ICO. A SAFT is a specific type of fundraising used by an increasing number of digital-currency startups. Directed at accredited investors, a SAFT promises tokens only when the company begins formal operations. While seemingly similar to an ICO, there is a key distinction. Under a standard ICO, the tokens are issued immediately to investors, while under a SAFT, the immediate return is only a promise to deliver tokens.
A SAFT allows you a level of functionality even though your network or token platform may not be live and you may not be properly prepared to set a value on future tokens yet to be issued. One thing a SAFT cannot do, however, is function as a tool to circumvent the Securities and Exchange Commission. Any tokens you issue upon conversion of a SAFT may well be a securities token. If so, that token is governed by all applicable U.S. federal and state securities laws, meaning you must plan accordingly for issuing that securities token.
At IBC, our network of attorneys can assist you in deciding whether you should issue a SAFT or bypass the SAFT entirely by directly issuing a securities token. We can help you find the right lawyers to draft your SAFT or your securities token purchase agreement, depending on the specific needs and circumstances associated with your ICO.
As an increasing number of startups choose to finance large digital-currency projects through initial coin offerings, SAFTs have gained traction, but not without considerable debate in the cryptocurrency community. The Wall Street Journal reports that over 60 companies have raised a combined $564 million via SAFTs issued during the presale period.
The rise of SAFTs come at a time when regulatory bodies, including the Securities and Exchange Commission and the Commodity Futures Trade Commission, are cracking down on such fundraising. Regulators are pushing aggressively for coin offerings like ICOs to be labeled as securities so they can fall under the jurisdiction of federal and state securities laws. Regulators have expressed concern that the nature of a SAFT- whereby no tokens are issued upfront- is part of a scheme to sidestep the regulatory reach of the SEC and CTFC.
Startups often turning to SAFTs because they can avoid registering their offerings with the SEC. Additionally, private funds often skip the process of registering their assets as securities altogether when selling to accredited investors. This may be one reason SAFTs target those types of buyers.
A major risk for anyone associated with a SAFT, however, is the looming threat of a regulatory crack down. Should the SEC or any other regulatory body determine that a promissory agreement such as a SAFT should be registered as a security, you will have to deal with the ramifications of your choice. Experts warn ICOs to exercise caution when structuring a SAFT deal specifically in terms of regulatory concerns.
The caution is not without merit; if regulators do crack down on SAFTs, they could determine that your company inadvertently acted as an unregistered broker-dealer under U.S. securities law. If so, there is a real risk of having your contract rescinded, meaning where the contract is voided and the parties are under no obligation to comply with the agreed upon terms and conditions.
Because regulators have yet to rule on SAFTs, recent legal rulings suggest a cautious approach for most ICOs may be prudent. For example, the “Howey Test” was created by the SEC as the result of a case titled “Securities and Exchange Commission v. W.J. Howey Co.” If specific transactions are determined to be investment contracts, they would fall under the Securities Act and are categorized as securities. By developing a standard to determining whether certain transactions qualify as “investment contracts,” the SEC is signaling its intent to impose stricter regulatory guidelines in the future.
Given the high stakes, choosing the proper team to guide you through the difficult decisions facing your company during your ICO. Ill-advised choices have serious consequences, and you need to surround yourself with the right people who have the expertise to help you make the right decisions from the outset. At IBC, we have access to some of the finest legal minds in the crypto community to provide first-rate counsel with a personal touch.