United States: SEC Qualifies First Token Offerings Under Regulation A

Last Updated: July 23 2019
Article by Cooley LLP

On July 10 and July 11, 2019, the US Securities and Exchange Commission (the SEC) qualified the Regulation A token offerings of Blockstack PBC and YouNow, Inc., nearly two years after the DAO Report and a year and half after Chairman Jay Clayton stated that he had yet to see an ICO that did not have a sufficient number of hallmarks of a security. The offerings were qualified under Tier 2 of Regulation A and cover: (1) for Blockstack the offer and sale of Stack Tokens to current holders of non-binding vouchers, to qualified purchasers and the distribution of the Stack Tokens for non-cash consideration pursuant to the issuer's bounty program; and (2) YouNow to distribute up to $50 million Prop Tokens as in-app rewards.

The qualifications represent an exciting milestone for the blockchain industry, potentially creating an alternative path for financing the development of blockchain networks and distributing digital assets via Regulation A. However, whether Regulation A represents a viable and efficient path for offerings and distributions of digital assets continues to hinge on further regulatory action.

The path to qualification for both companies involved a lengthy timeline due to the SEC staff's review and comment process associated with qualification of Form 1-As. Blockstack filed an initial non-public draft offering statement on September 13, 2018. The 10 month review and comment process likely followed many months of preparing the offering circular disclosures, including audited financial statements, prior to the initial filing. Blockstack disclosed costs of the offering as $2.8 million. Qualified offerings will also have ongoing reporting obligations for at least one year from qualification pursuant to the rules governing Regulation A, Tier 2 offerings. It is clear from the amendments to the issuer's respective Form 1-A's and correspondence letters with the SEC, that blockchain companies are fully capable of satisfying the SEC's regulatory disclosure requirements.

The extended and uncertain timeline and costs associated with the SEC disclosure review process may cause many issuers to eschew the Regulation A alternative. Both of the companies that had Form 1-As recently qualified had raised capital in prior fundraisings, which may have given them the financial runway required to pursue Regulation A. Although the SEC is not a merit regulator, meaning that they do not pass upon the merits of a particular investment, the staff have the authority to require any disclosures deemed material to achieve "full and fair" disclosure so that an investor can make an informed investment decision. This authority, however, can result in significant delays to qualification of a Regulation A filing (or a registration statement that is subject to the same review) as the staff determines what may be material in the case of novel and unique investments, such as a digital asset that may not have a true issuer, among other disclosure challenges. Now that some have been qualified, will the staff's familiarity with these disclosures and the underlying technology potentially streamline and shorten this process?

Blockstack disclosed in the offering circular: "If the Stacks Tokens are issued, there may not be a trading market available for the Stacks Tokens, or any digital token exchange on which holders of Stacks Tokens may transfer or resell their Stacks Tokens. As a result of recent regulatory developments, existing crypto exchanges are currently unwilling to list tokens such as the Stacks Tokens that may be deemed as securities under federal securities law. As a result, the tokens may initially only be traded on very limited range of venues, including US registered exchanges or regulated alternative trading systems for which a Form ATS has been properly submitted to the SEC." The disclosure continues by noting that "As far as we are aware, there are currently no national securities exchanges or exchanges that have been approved by the [FINRA] or registered under Form ATS with the SEC... to support the trading of Stacks Tokens on the secondary market."

A significant challenge to the viability of Regulation A as an option for utility tokens seeking regulatory certainty or true security tokens is the lack of secondary markets noted by Blockstack. On this point exactly, the SEC and the Financial Industry Regulatory Authority (FINRA) released a joint statement on July 8, 2019, identifying some of the regulatory issues both are considering regarding the custody of digital assets by broker-dealers operating a registered exchange or ATS and intermediation of digital asset transactions. Unfortunately, the statement provided little insight and no resolution, but rather it summarized the various issues and regulatory questions that FINRA applicants have highlighted for FINRA and SEC staff for months, leaving many to wonder if the joint statement was simply a statement designed to communicate to the industry that they are aware of the legal and regulatory issues that must be addressed, but that they need more time to issue guidance that will allow FINRA broker-dealer applicants and ATS platforms to launch and begin to support trading in digital securities. Until there is guidance in these areas, the many companies reported to be ready and waiting for FINRA approval will be unable to provide the platforms and tools needed to support a viable and liquid secondary market for tokens treated as securities, and, as a result, it is unclear how those utilizing Regulation A will provide developers, miners or users with monetization options or incentives to drive growth and adoption.

Blockstack's disclosure states that it "anticipates treating the Stack Tokens as securities based on our view that the tokens are 'investment contracts' under the recent guidance provided by the SEC 'Framework for 'Investment Contract' Analysis of Digital Assets' ... and the application of the test under [Howey]." Blockstack's offering also emphasizes the issuer's intention for the Stack Tokens to "transform" at some point into the future so as to no longer qualify as securities, describes the efforts it will take to achieve this (see below) and that the company's board intends to make this determination, triggering among other things the end of reporting obligations. The board will base this decision upon "whether the Blockstack network is sufficiently decentralized," which will in part "depend on whether purchasers of Stack Tokens reasonably expect Blockstack to carry out essential managerial or entrepreneurial efforts, and whether Blockstack retains a degree of power over the governance of the network such that its material non-public information may be of special relevance to the future of the Blockstack network." 

Blockstack's analysis of when a token transforms to no longer be a security draws heavily from FinHub's April 3 Framework for "Investment Contract" Analysis of Digital Assets and may provide insight into the primary considerations the SEC will weigh when evaluating whether a digital asset has "transformed" from security to non-security. This disclosure continues to articulate the SEC staff's views, expressed in the Framework and by Director William Hinman in his June 2018 speech that a digital asset, initially classified as a security and subject to securities laws, can later be offered and sold as a non-security over time. We agree that it is the manner of offer and sale that may result in an "investment contract" as opposed the the digital asset itself, in most cases, being an enumerated security. Like Blockstack and its legal advisors (we assume), we have no indication, let alone clarity, from the SEC staff as to the point at which such a transformation may occur or which of the Framework's 30 factors may, alone or in combination, trigger such a flip. Until the SEC clarifies the point of "transformation" blockchain companies interested in conducting token offerings in the US under Regulation A will face similar uncertainty as to the future status of their tokens as securities as those that used other means of financing their network or application. Those seeking to utilize Regulation A may ultimately submit themselves to the discretion and consent of SEC staff that such a triggering point has been reached, putting the SEC in the role of merit regulator rather than arbiter of "full and fair disclosure," which would be a significant departure from the staff's statutory mandate and its core mission.

The qualifications of token offerings pursuant to Regulation A represent a welcome alternative to private placements and foreign offerings, though all remain viable options for blockchain-based projects to consider. However, the uncertainty surrounding the future status of tokens as securities and lack of secondary trading markets may limit, for now, the overall viability of Regulation A for sale or distribution of digital assets. For the security token market to develop as a meaningful alternative for digital asset projects, the SEC and FINRA must still address the various legal issues identified in their July joint statement to allow compliant trading platforms, broker-dealers and other financial intermediaries necessary to support liquid and efficient markets for digital securities.

Notes

  1. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Exchange Act Release No. 81207 (July 25, 2017).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions