The establishment of a framework for security tokens in the U.S. is critical to the widespread adoption and further development of blockchain technology. For the moment, however, these new types of securities must continue to operate under policies that date back to a time long before the Internet.
The Securities Act of 1933, colloquially referred to as the “Securities Act” or the “33 Act,” regulates securities offerings in the US. All offerings must be registered under Section 5 of the Securities Act or meet a pre-established exemption from registration. Any issuer offering or selling security tokens in the US must abide by the requirements of the Securities Act.(1)
Practically speaking, registering an offering means a significant commitment of time and resources, including SEC approval and ongoing compliance obligations under the Securities Exchange Act of 1934, discussed next. A full public offering is done pursuant to a registration statement on Form S-1 (or Form F-1 for foreign issuers). There is also a form of limited public offering under Reg
ulation A (known colloquially as “A+” because Congress several years ago increased the maximum offering size), which has an offering circular requirement similar to, but less comprehensive than, a registration statement and that results in certain disclosure and filing requirements that resemble a lighter version of the public offering. To date, two companies have been allowed to utilize Regulation A+ for blockchain tokens, which requires an SEC declaration that the company’s offering circular is “qualified.”(2)
Exempt offerings(3) come in many flavors besides Regulation A, with security token issuers often relying on Regulation D (private offerings) and Regulation S (non-US offerings). A single offering may rely on both exemptions simultaneously, Reg D for US purchasers and Reg S for non-US investors.
Because they are exempt, these offering types do not have formal disclosure requirements imposed by statute or rule, but informal practices have arisen that vary with the type of security token, the target investors, and other factors.
When doing a series of offerings that rely on one or more exemptions, issuers need to be careful that their offerings are not collapsed into a single offering that might require registration. This is known as “integration” of the offerings and requires careful analysis.
A few other matters to keep in mind for offerings that rely on Reg D:
- They are limited to sophisticated investors, which are subject to evolving standards but usually focus on the investor’s net worth or income (so-called “accredited investors”).
- Reg D issuers can be disqualified under the “bad actor” provisions, which prohibit issuers from using Reg D if they or their officers, directors, or shareholders have engaged in wrongful conduct. (A waiver process is available through the SEC.)
- The issuer must file a notice on Form D with the SEC and various states to provide information about the offering to regulators.
- The securities sold will be subject to significant resale restrictions, often for at least one year.
Reg S offerings have various requirements to ensure that the offering is truly non-US in nature and that prevent securities sold offshore from being purchased by US investors. Issuers relying on this exemption need to pay careful attention to the detailed requirements. It is important to have sophisticated legal counsel to advise on either a public offering or an exempt offering.
In the next article, we will discuss the few projects that have used full registration or Regulation A offerings, and we will look at the ongoing requirements for a public company. Regulation D and Regulation S offerings were much more numerous and were used in a variety of circumstances.
1 Securities Act of 1933
2 Full registered token offering: INX registration statement; Regulation A+ token offerings: YouNow offering circular; Blockstack offering circular
3 SEC information on exempt offerings
This article is an extract from the 90+ page Security Token Report 2021 co-published by the Crypto Research Report and Cointelegraph Consulting, written by thirteen authors and supported by Crypto Finance, Blocklabs Capital Management, HyperTrader, Ten31 Bank, Stadler Völkel Attorneys at Law, Riddle&Code, Coinfinity, Bitpanda Pro, Tokeny Solutions, AlgoTrader, and Elevated Returns.