The Securities & Exchange Commission (the "SEC") has an inherent economic role of facilitating capital formation, meaning, from an economic standpoint, the SEC is also partly responsible for finding and regulating new and innovative ways by which members of the public pool capital together to invest in and promote economic activity. Within that context, the SEC's decision to regulate the investments by members of the public in the purchase of digital assets1 is highly commendable. The Digital Asset Regulation also formalizes another route for tech startups and fintechs to raise venture capital outside of institutional venture capital. This is generally a good development for innovative technology companies and fintechs.
The following summarizes our thoughts on some of the questions that have arisen following the issuance of the Digital Asset Regulations:
- Why is the SEC regulating the sale of Digital
Because, the primary duty of the SEC is to protect members of the public who invest in the securities of public companies. If indeed more Nigerians are now investing in digital assets2, it does makes sense for the SEC to take steps to protect such Nigerians from fraudulent, naive or incompetent actors. With the Digital Asset Regulations, the SEC is essentially putting a process in place to ensure that only the most reputable and credible actors sell digital assets to Nigerians.
- What is the SEC's Strategy for Regulating the Sale
of Digital Assets to members of the Public?
- By requiring any local or foreign company (referred to as
the "Issuer") who intends to sell
digital assets to Nigerians to first submit a white paper to the
SEC for review and approval. Within 35 days of submitting a white
paper, the SEC will notify the Issuer of its decision on whether or
not the digital asset proposed to be offered, is a security. The
implication of this step in the process is that, if the SEC decides
that the digital asset being offered is not a security, there would
be no obligation on an Issuer to register the digital assets with
the SEC as securities. Where the SEC determines that a digital
asset is a security, the SEC will then formally register the
digital asset offering.
- By requiring that, the directors and senior management of an
Issuer must, in aggregate, own at least 50% of an Issuer at the
time they offer the digital assets to the public. A lock-in period
is also imposed on the shares of directors and senior management of
the Issuer, in that, they can't sell more than 50% of their
individual shares until the project for which the monies were
raised is completed.
- By limiting the amount Issuers can raise in an offering within
a 12-month period to N10,000,000,000 (Ten Billion Naira).
- By limiting the amount of digital assets that retail investors
can purchase in a public offering, within a 12-month period to
N2,000, 000 (Two million naira). If you have a net worth of over
N100,000, 000 (One Hundred Million Naira) and you can prove that
you understand the risky nature of an investment in digital assets
or that you have access to professional advice, there is no limit
to the amount you can buy in a digital asset offering. Also, if you
are a qualified institutional investor (like a pension
fund), there are no limits to the amount of digital assets you
can buy3. The SEC is essentially saying, if it's a
highly risky investment, maybe you shouldn't put too much money
- By requiring that Nigerian Platforms that allow companies to
(i) sell/offer digital assets (ii) exchange digital assets (iii)
operate wallets or take custody of digital assets (iv) provide
services in the digital asset ecosystem, must now formally register
with the SEC. Not only that, companies playing in these verticals
must now comply with specific technology, corporate governance,
risk and portfolio management standards.
- By requiring any local or foreign company (referred to as the "Issuer") who intends to sell digital assets to Nigerians to first submit a white paper to the SEC for review and approval. Within 35 days of submitting a white paper, the SEC will notify the Issuer of its decision on whether or not the digital asset proposed to be offered, is a security. The implication of this step in the process is that, if the SEC decides that the digital asset being offered is not a security, there would be no obligation on an Issuer to register the digital assets with the SEC as securities. Where the SEC determines that a digital asset is a security, the SEC will then formally register the digital asset offering.
- Why Does the SEC have to First Determine Whether or Not
a Digital Asset is a Security?
Because it is possible that, a digital asset is a commodity or currency and not a security. The SEC's primary role is to regulate securities, and not commodities per se4. Generally, tokens, coins, or digital assets that simply act as replacements of traditional fiat currency and do not provide any equity or debt claim on an Issuer, are not considered as securities and are more likely to be considered as commodities or currency. The Digital Asset Regulations do not indicate the principles which the SEC will follow in reaching a decision on whether a digital asset is a security or not. In the United States, the principles are clearer. To be considered as security in the United States, a digital asset must involve (a) the investment of money by an individual (b) in a common enterprise (c) with a reasonable expectation of profits to be derived from the efforts of others.5
- Does the Digital Asset Regulation Conflict with the
Existing CBN Crypto Prohibition Regulation?
From a legal standpoint, there is no conflict because the CBN and the SEC regulate different economic activities. From a regulatory standpoint, the SEC is not really concerned about the means of exchange by which you buy a digital asset. Whereas, the CBN is the entity primarily responsible for regulating currency. The SEC is essentially saying if you buy any type of security, we want to be sure that the sellers of these securities meet certain customer/investor protection requirements. The SEC has no "currency" jurisdiction. Accordingly, the Digital Asset Regulations do not contradict the existing CBN crypto-prohibitions and financial institutions are still bound by the CBN Regulations prohibiting dealings in cryptocurrency6.
- Companies/Fintechs that Issue Utility Tokens Need Not
Register with the SEC
The Digital Asset Regulations defines a "Digital Asset" as a digital token that represents a debt or equity claim on an Issuer. On the other hand, utility tokens do not give their holders an equity or debt claim over an Issuer and are not generally considered as investments7. Generally, utility tokens provide their holders the right to buy a product or service on preferential terms. Such preferential terms can be in the form of exclusive access to services or a discounted rate for a product or service. Based on the SEC's definition of digital asset, it appears (and understandably so) that the SEC does not intend to regulate the sale of utility tokens to the public.8
- What Happens if You Do Not Comply with the Digital
The Investment & Securities Act gives the SEC the powers to freeze your bank accounts, impose fines, take over the management of your "crypto" business, and where considered appropriate, shut down the business. The SEC also has a whistleblowing policy here, meaning that anybody can report you to the SEC for investigation and provide incriminating evidence. Regardless, fintechs that have any dealings in cryptocurrency shouldn't assume that the Digital Asset Regulations apply to them by default and should seek competent legal opinion to chart the best way forward. In the meantime, it would also be prudent for tech companies and fintech platforms that have dealings with crypro-currencies to notify users that they are aware of and reviewing the Digital Assets Regulations and to subsequently notify users of their position regarding the applicability of the Digital Asset Regulation to their operations and any possible impact (including costs) on users.
- What are Some of the Legal Issues Arising from the
Digital Asset Regulations?
- The Digital Asset Regulations effectively creates an exception
to section 67 of the ISA, because the SEC is essentially inviting
"private companies" to offer securities to the public.
Whereas, section 67 of the Investment and Securities Act, prohibits
a private company from offering securities to the public. In
practice, private companies are required to first convert to public
companies as part of the process of going public. The legal
question that arises here is whether or not the SEC can
administratively create this exception without legislative
approval. It would be useful for the SEC to clarify this
- The Digital Asset Regulation defines a "Digital Asset
Offering", as including "ICOs and other Distributed
Ledger Technology offers of digital assets". The language
suggests that the SEC will regulate not only public offerings of
digital assets but also private token/coin offerings, in so far as
those private offerings are offered using "Distributed
Ledger Technology". In our view, there is no legal basis
upon which the SEC can regulate private coin offerings, because the
scope of administrative authority conferred on the SEC only covers
public offers of securities and private offerings of venture
capital securities.9 It would be useful for the SEC
to clarify this point.
- The Digital Asset Regulations effectively creates an exception to section 67 of the ISA, because the SEC is essentially inviting "private companies" to offer securities to the public. Whereas, section 67 of the Investment and Securities Act, prohibits a private company from offering securities to the public. In practice, private companies are required to first convert to public companies as part of the process of going public. The legal question that arises here is whether or not the SEC can administratively create this exception without legislative approval. It would be useful for the SEC to clarify this point.
- Will Investors Be Entitled to Compensation under the
Investors Protection Fund?
In 2017, the SEC issued the National Investors Protection Fund Regulations, with the aim of compensating investors who lose money as a result of the fraudulent or illegal activities of a capital market operator. Based on the language of the Digital Asset Regulations which requires the Digital Asset Regulations to be read in conjunction with the rules of the SEC, it appears that investors in digital assets will also be entitled to compensation under the fund and that Issuers would be expected to make annual contributions to this Fund.
1. On May 11, 2022, the SEC issued the New Rules on Issuance, Offering Platforms, and Custody of Digital Assets (Digital Asset Regulations).
2. broadly, digital tokens, coins or cryptocurrencies
3. It might be useful for the SEC to revisit the definition of accredited investor/institutional investor as it relates to digital asset offerings. For one, it is not likely that qualified institutional investors in Nigeria will invest in cryptocurrency. Also, venture capital firms should generally be considered to be qualified institutional investors
4. Although, the SEC regulates commodity exchanges as well.
5. This rule was laid down in the case of SEC vs W.J Howey Co., 328 U.S 293(1946)
6. On Monday, May 16th, 2022, the Federal High Court in Lagos threw out a suit filed by an NGO challenging the CBN regulation prohibiting banks from dealing in cryptocurrencies.
7. This is probably why the SEC does not feature utility tokens in its Digital Asset Regulations.
8. Nonetheless, we think that the utility token market deserves some level of regulation because there can be customer protection and public interest issues in the public offer of utility tokens. The big question here is: who should regulate utility tokens?
9. See sections 13(c) (d) & (h) of the ISA
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.