You are reading this because you or someone you know wants to launch an Initial Coin Offering or Initial Token Offering (“ICO”) in 2018. You also may not know exactly how to get started but there is one thing you are absolutely certain of: you want to raise capital without violating the federal or state securities laws or receiving a subpoena from the U.S. Securities and Exchange Commission (“SEC”). If this describes you, then please continue reading as I briefly outline the answers to some frequently asked questions about how to launch a compliant ICO.
When will the Federal or State Securities Laws apply to my Token Sale?
The answer depends on whether your token sale involves a utility or security token. This determination will require a facts and circumstances analysis of the functionality of your token within the framework of your business development plan while taking into consideration a vast amount of case law that has applied the infamous Howey Test. Notwithstanding Chairman of the SEC Jay Clayton’s statement that “every ICO I have seen is a security,” if you are unsure about whether your token is a utility or a security, then you should schedule a consultation with one of our lawyers today. For the purposes of this blog, assume that your token is a security token. Remember these words: an offer or sale of securities must be registered, exempt from registration or it is a violation of the federal (and state) securities laws.
Should I Register my ICO?
Pros: You will be able to offer your security tokens to the public without worrying about accredited investor status and raise a potentially unlimited amount of capital. Also, your tokens will be completely free trading assuming there are SEC-registered token exchanges making markets in such tokens.
Cons: If you are interested in saving money, then this is not the best option for you. You will become subject to the full disclosure requirements of publicly traded companies such as annual, quarterly and current reports, and you will incur considerable expenses related to filing, legal, accounting and auditing fees.
Should I Rely on Regulation A as an Exemption from Registration?
Regulation A is an exemption from registration that requires a filing with the SEC and allows companies to offer and sell securities to the public but with more limited disclosure requirements than the option above.
Pros: You can raise up to $50 million in a Tier 2 Offering and sell to both accredited and non-accredited investors. The process of obtaining “Qualification” by the SEC is not as burdensome or costly as you may think if your Form 1-A is prepared by knowledgeable, experienced counsel, and you can file your Form 1-A with the SEC for confidential review allowing you to “test the waters” and build a following prior to Qualification.
Cons: You must be a U.S. or Canadian-based company and you will be subject to disclosure requirements, but these disclosure requirements are less burdensome than those associated with a registered ICO. Non-accredited investors are limited as to how much they can invest in any one offering.
Should I Rely on Regulation D as an Exemption from Registration?
Rule 506 of Regulation D is an available exemption from registration but issuers are required to file a Form D with the SEC and post-sale notice filings in one or more states may also be required.
Pros: Companies can raise unlimited amounts of money as well as broadly solicit and generally advertise the offering under Rule 506(c), so long as sales are made only to accredited investors. Also, offering disclosure documents and the filing of Form D and other state filings are typically less onerous than disclosure requirements of a Regulation A or fully registered offering.
Cons: Sales are limited to accredited investors and an issuer must verify accredited investor status. The sale of securities under Regulation D involves “restricted” securities (except for in certain limited circumstances) and investors must be comfortable with the required one-year holding period.
Should I Rely on Regulation CF as an Exemption from Registration?
A Regulation CF offering is an equity crowdfunded offering conducted on a regulated “portal” under the new rules and regulations of the JOBS Act.
Pros: Companies can sell to accredited and non-accredited investors. Compared to the exemptions described above, these disclosure requirements are the least burdensome and costs of the offering are much less as well.
Cons: Sales are limited to a maximum raise of $1.07 million in any 12-month period and the Company must be a U.S. company. Non-accredited investors are limited as to how much they can invest in all Regulation CF offerings in any 12-month period. The company must file a Form C with the SEC and comply with disclosure requirements. Transfer restrictions and one-year holding periods will apply to purchased securities.
Should I Rely on Regulation S as an Exemption from Registration?
Pros: This exemption can be combined with other exemptions, including those listed above, and is available for offerings of both equity and debt securities tokens.
Cons: Offers and sales of securities tokens must be conducted outside the U.S. and only to “non-U.S. persons.” Tokens or investment contracts such as SAFTs sold in a Regulation S offering will be restricted securities and holding periods will apply. An issuer using this exemption should consider setting up a geofence to block I.P. addresses in the U.S.
Can I use a SAFT instead?
A SAFT, or Simple Agreement for Future Tokens, can be used during the ICO pre-sale phase, however, it cannot not be used as a tool to circumvent the federal securities laws. The token that is issued upon conversion of the SAFT may very well turn out to be a security token governed by all applicable securities laws.
How will I issue my Token?
There are several companies that offer services to create smart contracts for the governance and operation of securities tokens and that provide related infrastructure services. Though our firm does not endorse any particular company, we would be happy to discuss.
Can I circumvent the securities laws by setting up a Bounty Program or other Promotional Activities?
Celebrity-endorsed ICOs such as those by Paris Hilton and Evander Holyfield have raised red flags with the SEC because offering incentivized rewards to help promote ICOs may be in violation of the anti-touting provisions of the federal securities laws. Bounty Programs, where people or companies are awarded free tokens for endorsing ICOs or for otherwise performing various tasks necessary to the successful completion of an ICO, may be deemed to be unregistered sales of equity securities. Similarly, “Air Drop” programs whereby a company’s supporters are issued free tokens may also violate securities laws. These activities should be carefully analyzed and monitored, and we strongly suggest that you clear all such activities with securities counsel before beginning your marketing campaign.
Some states may consider this an attorney advertisement. I am not your attorney and this is not legal or investment advice. However, if you are interested in launching an ICO, please contact us at email@example.com or by phone at 202-869-0888 (ext. 100). We have a group of attorneys that are focused on legal and regulatory compliance in the area of cryptocurrency and ICOs.
Bevilacqua PLLC is a boutique corporate and securities transactional law firm that understands entrepreneurs and provides goal oriented legal services that facilitate agreement and closure. Our partners have been handling complex domestic and international transactional matters for over two decades and have the business experience to give context to the legal services that we provide. Learn more about our firm at www.bevilacquapllc.com.